DOB: Goldman Sachs - ARS Consent Order

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IN THE MATTER OF:

GOLDMAN, SACHS & CO.


(CRD No. 361)


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CONSENT ORDER

DOCKET NO. CO-10-7842-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, Goldman, Sachs & Co. (“Goldman Sachs” or “Respondent”) is a broker-dealer registered in the state of Connecticut;
 
WHEREAS, the Commissioner, through the Securities and Business Investments Division (the “Division”) of the Department of Banking and pursuant to Section 36b-26(a) of the Act, conducted a coordinated investigation with other states into Goldman Sachs’ activities in connection with the marketing and sale of auction rate securities (“ARS”);
 
WHEREAS, Goldman Sachs has cooperated with regulators conducting the investigations by responding to inquiries, providing documentary evidence and other materials, and providing regulators with access to facts relating to the investigations;
 
WHEREAS, Goldman Sachs has advised regulators of its agreement to resolve the investigations relating to its marketing and sale of ARS to individual investors;
 
WHEREAS, Goldman Sachs agrees to take certain actions described herein and to make certain payments;
 
WHEREAS, in resolution of the matters described herein, Goldman Sachs has agreed inter alia, to pay a total fine of Twenty-two Million Five Hundred Thousand Dollars ($22,500,000) to all the jurisdictions, including Connecticut, involved in the multistate investigation;
 
WHEREAS, Goldman Sachs has repurchased at par and on the same terms and conditions all Eligible ARS from Eligible Investors nationally who accepted and complied with the terms and conditions of the firm’s repurchase offer;
 
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 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 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;

II. CONSENT TO WAIVER OF PROCEDURAL RIGHTS

WHEREAS, Goldman Sachs, 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) 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 itself 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 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

1. Goldman Sachs admits the jurisdiction of the Commissioner, neither admits nor denies the Findings of Fact and Conclusions of Law contained in this Consent Order, and consents to the entry of this Consent Order by the Commissioner.
2. Nothing in this Consent Order shall be construed as a finding or admission of fraud by Goldman Sachs.

IV. RESPONDENT

3. Goldman Sachs has been registered as a broker-dealer under the Act since November 30, 1931;
4. Goldman Sachs maintains its principal office at 200 West Street, New York, New York  10282;

V. FINDINGS OF FACT

5.

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 that pay an interest rate that resets periodically through a bidding process known as a Dutch auction.

6. Goldman Sachs participated in the marketing and sale of ARS.
7. Goldman Sachs acted as an underwriter and as the auction broker-dealer for certain issues of auction rate securities.  When acting as sole manager, Goldman Sachs 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 in such auctions.  When acting as lead manager, Goldman Sachs was the primary firm that could submit bids into the auction, but other auction broker-dealers were able to submit orders on behalf of their clients as well.  Goldman Sachs 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.
8. Goldman Sachs conveyed to certain clients that ARS were secure, liquid securities that were a suitable alternative for cash management purposes.  It did so through its sales force, some of whom represented to certain investors that auction rate securities were highly liquid, safe investments for cash management purposes.
9. 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 cannot sell their auction rate securities in that auction and are potentially stuck holding long-term investments, not money market instruments.  As discussed below, starting in the Fall of 2007, the auction rate securities market faced dislocation and an increased risk of auction failure.
10. Since it began participating in the auction rate securities market, Goldman Sachs submitted “cover” bids, purchase orders for the entirety of an auction rate security issue for which it acted as the sole or lead auction manager.  Such “cover” bids were Goldman Sachs proprietary orders that would be filled, in whole or in part, if there was otherwise insufficient demand in an auction.  When Goldman Sachs purchased auction rate securities through “cover” bids, those auction rate securities were then owned by Goldman Sachs, and the holdings were recorded on Goldman Sachs’ balance sheet.  For risk management purposes, Goldman Sachs imposed limits on the amounts of securities its Municipal Money Markets unit could hold (which included Goldman Sachs’ auction rate securities holdings).
11. Because many investors could not ascertain how much of an auction was filled through Goldman Sachs “cover” bids, those investors could not determine if auctions were clearing because of normal marketplace demand, or because Goldman Sachs was making up for the lack of demand through “cover” bids.  Many investors were also not aware that the liquidity of the auction rate securities was dependent upon Goldman Sachs’ continued use of “cover” bids.  While Goldman Sachs could track its own inventory as a measure of the supply and demand for its auction rate securities, many investors had no comparable ability to assess the operation of the auctions.  There was no way for those 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.
12. In August of 2007, the credit crisis and other deteriorating market conditions began to strain the auction rate securities market.  Some institutional investors withdrew from the market, decreasing demand for auction rate securities.
13. The resulting market dislocation should have been evident to Goldman Sachs. When client demand for its auction rate securities declined, Goldman Sachs’ “cover” bids filled the increasing shortfall, thereby sustaining the impression for certain investors that auctions managed by Goldman Sachs were functioning.  As a result, Goldman Sachs’ auction rate securities inventory grew significantly, requiring Goldman Sachs to raise its risk management limits for its Municipal Money Markets business (which included auction rate securities) several times.
14. From the Fall of 2007 through early February of 2008, demand for auction rate securities continued to erode, and Goldman Sachs’ auction rate securities inventory increased significantly.  Goldman Sachs was aware of the increasing strains in the auction rate securities market, and increasingly questioned the viability of the auction rate securities market.  Goldman Sachs did not disclose these increasing risks of owning or purchasing auction rate securities to all of its clients.
15. In February of 2008, Goldman Sachs and other firms stopped supporting auctions.  Without the benefit of “cover” bids, the auction rate securities market collapsed, leaving certain investors who had been led to believe that these securities were liquid, safe investments appropriate for managing short-term cash needs, holding long-term or perpetual securities that could not be sold at par value until and if the auctions cleared again.

Failure to Supervise

16. Goldman Sachs did not adequately supervise certain of its salespeople to ensure that all of the firm’s clients would be sufficiently apprised of ARS, the mechanics of the auction process, and the potential illiquidity of ARS, including the fact that Goldman Sachs may stop submitting “cover” bids, as discussed above.

VI. CONCLUSIONS OF LAW

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

VII. CONDITIONS PRECEDENT

As conditions precedent to the entry of this Consent Order, Goldman Sachs represents, through its execution of this Consent Order, that it has complied or will comply with the following requirements and representations:

Requirement to Repurchase ARS from Retail ARS Investors

1.   Goldman Sachs shall have provided liquidity to Eligible Investors by offering to buy back Eligible ARS that since February 11, 2008, have not been auctioning, at par, in the manner described below.
 
2. “Eligible ARS”, for the purposes of this Consent Order, shall mean auction rate securities purchased from Goldman Sachs on or before February 11, 2008.
   
3. “Eligible Investors”, for the purposes of this Consent Order, shall mean:  (i) Natural persons (including their IRA accounts, testamentary trust and estate accounts, custodian UGMA and UTMA accounts, and guardianship accounts); (ii) Legal entities forming investment vehicles for closely related individuals, including but not limited to, IRA accounts, Trusts, Family Limited Partnerships, and other legal entities performing a similar function; (iii) Charities and non-profits with Internal Revenue Code Section 501(c) status that purchased Eligible ARS from Goldman Sachs; and (iv) Small Businesses that purchased Eligible ARS from Goldman Sachs.  For purposes of this provision, “Small Businesses” shall mean Goldman Sachs clients not otherwise covered in paragraphs VII.3.(i) and (ii) above that had $10 million or less in assets in their accounts with Goldman Sachs, net of margin loans, as determined by the client’s aggregate household position(s) at Goldman Sachs as of August 31, 2008, or, if the client was not a client of Goldman Sachs as of August 31, 2008, as of the date that the client terminated its client relationship with Goldman Sachs.  Notwithstanding any other provision, “Small Businesses” does not include broker-dealers or banks acting as conduits for their customers.
 
4.  Goldman Sachs shall have offered to purchase, at par plus accrued and unpaid dividends/interest, from Eligible Investors their Eligible ARS that since February 11, 2008 have not been auctioning (“Buyback Offer”), and shall have explained what Eligible Investors were required to do to accept, in whole or in part, the Buyback Offer.  The Buyback Offer shall have remained open until at least November 12, 2008 (“Offer Period”).  Goldman Sachs may extend the Offer Period beyond this date.
 
5.  Goldman Sachs shall have undertaken its best efforts to identify and provide notice to Eligible Investors who invested in Eligible ARS that since February 11, 2008 have not been auctioning of the relevant terms of the multistate settlement.
 
6. Eligible Investors may have accepted the Buyback Offer by notifying Goldman Sachs at any time before midnight, Eastern Time, November 12, 2008, or such later date and time as Goldman Sachs may extend the Offer Period.  For Eligible Investors who accepted the Buyback Offer within the Offer Period, Goldman Sachs shall have purchased the Eligible ARS on or before November 17, 2008 (or a later date if an offer period is extended).  For Eligible Investors who accepted the Buyback Offer within the Offer Period but custodied their Eligible ARS away from Goldman Sachs, Goldman Sachs shall have repurchased the Eligible ARS upon receipt of assurance reasonably satisfactory to Goldman Sachs from the Eligible Investor’s current financial institution that the bidding rights associated with the Eligible Auction Rate Securities would be transferred to Goldman Sachs.
 
7. No later than December 31, 2009, any Eligible Investor who for good cause (including but not limited to incapacity or failure to receive the notice provided for in paragraph VII.4.) did not accept the Buyback Offer pursuant to paragraph VII.5. above, shall be entitled to sell their Eligible ARS, at par, to Goldman Sachs for thirty (30) days after establishing such good cause, and Goldman Sachs shall have purchased such Eligible Investor’s Eligible ARS promptly.
 
8. No later than October 20, 2008, Goldman Sachs shall have established a dedicated toll-free telephone assistance line, with appropriate staffing, to provide information and to respond to questions from clients concerning the terms of the multistate settlement with Goldman Sachs described herein.

Review of Client Accounts

9.    For a period of two years from the date this Consent Order is entered by the Commissioner, upon request from any firm that is repurchasing auction rate securities, upon receipt from the repurchasing firm of (i) the names of any Goldman Sachs clients that may hold ARS subject to the repurchasing firm’s repurchase offer, (ii) the CUSIPs of the Eligible ARS, (iii) the clients’ Goldman Sachs account number(s) (if known to the repurchasing firm), and (iv) the date those ARS were transferred to Goldman Sachs (if known to the repurchasing firm), Goldman Sachs shall take reasonable steps to provide notice to those clients of the repurchasing firm’s repurchase offer.

Relief for Investors Who Sold Below Par

10.   By November 12, 2008, Goldman Sachs shall have undertaken its best efforts to identify any Eligible Investor who sold Eligible ARS below par between February 11, 2008 and August 21, 2008, and shall have paid any such Eligible Investor the difference between par and the price at which the Eligible Investor sold the Eligible ARS.

Reimbursement for Related Loan Expenses

11.   Goldman Sachs shall have made best efforts to identify Eligible Investors who took out loans from Goldman Sachs between February 11, 2008 and March 19, 2010 that were secured by Eligible ARS that were not successfully auctioning at the time the loan was taken out from Goldman Sachs, and 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.  Goldman Sachs shall have reimbursed such clients for the excess expense, plus reasonable interest thereon.  Such reimbursement shall have occurred no later than March 31, 2010.

Claims for Consequential Damages

12.   Goldman Sachs shall consent to participate in a special arbitration (“Arbitration”) for the exclusive purpose of arbitrating any Eligible Investor’s consequential damages claim arising from their inability to sell Eligible ARS.  Goldman Sachs shall have provided written notice to Eligible Investors of the terms of the Arbitration process on or before November 12, 2008.
  
13. 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, effective April 16, 2007), under the auspices of FINRA.  Goldman Sachs will pay all applicable forum and filing fees.  Any Eligible Investors who choose 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 Auction Rate Securities.
  
14. In the Arbitration, Goldman Sachs shall be permitted to defend itself against such claims; provided, however, that Goldman Sachs shall not contest in these arbitrations liability related to the sale of auction rate securities, or use as part of its defense any decision by an Eligible Investor not to borrow money from Goldman Sachs.
  
15. Eligible Investors seeking consequential damages who elect to use the special arbitration process provided for herein shall not be eligible for punitive or special damages. 
 
16. Eligible Investors who elect to utilize the special arbitration process set forth above are limited to the remedies available in that process and may not bring or pursue a claim against Goldman Sachs or in any case where Goldman Sachs is an underwriter relating to Eligible Auction Rate Securities in another forum.

Institutional Investors

17.   Goldman Sachs shall endeavor to work with issuers and other interested parties, including regulatory and governmental entities, to expeditiously provide liquidity solutions for institutional investors not covered by paragraph VII.1. above that purchased auction rate securities from Goldman Sachs prior to February 11, 2008 (“Institutional Investors”).
  
18. Beginning November 12, 2008, and within 45 days of the end of each Goldman Sachs fiscal quarter thereafter, Goldman Sachs shall have submitted a written report to the Illinois Securities Department or other representative specified by the North American Securities Administrators Association, Inc. (“NASAA”) outlining Goldman Sachs’ progress with respect to its obligations under the multistate settlement.  Goldman Sachs shall have, at the option of the Illinois Securities Department or other representative specified by NASAA, conferred with such representative on a quarterly basis to discuss Goldman Sachs’ progress to date.  Such quarterly reports and conferences shall have continued until December 31, 2009.  Following every quarterly report, the representative shall have advised Goldman Sachs of any concerns regarding Goldman Sachs’ progress, and, in response, Goldman Sachs shall have discussed how Goldman Sachs plans to address such concerns.  The reporting or meeting deadlines may be amended with written permission from the Illinois Securities Department or other representative specified by NASAA.

Relief for Municipal Issuers

19.   Goldman Sachs shall promptly refund to municipal issuers refinancing fees paid to Goldman Sachs for the refinancing or conversion of their auction rate securities that occurred between February 11, 2008 and the date this Consent Order is entered by the Commissioner, where Goldman Sachs acted as underwriter for the initial primary offering of the auction rate securities between August 1, 2007 and February 11, 2008.
  
20. Goldman Sachs agrees to waive any right to indemnification and/or claims of contribution, and/or other similar remedies with respect to any costs, expenses or losses in connection with the conduct described herein that Goldman Sachs may have against any municipal issuers that issued securities through Goldman Sachs in the primary market, including any student loan authority.

VIII. CONSENT ORDER

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

IT IS HEREBY ORDERED THAT:

1.
This Consent Order concludes the investigation by the Commissioner, and any other action that the Commissioner could commence under the Act and the Regulations as it relates to Goldman Sachs’ marketing and sale of auction rate securities to Goldman Sachs’ Eligible Investors, as defined above.  Nothing in this Consent Order precludes the Commissioner from pursuing any other enforcement action that may arise with regard to auction rate securities other than the marketing and sale of auction rate securities to retail investors.
2.
This Consent Order is entered into solely for the purpose of resolving the investigation into Goldman Sachs’ marketing and sale of auction rate securities, and is not intended to be used for any other purpose.
3.
Goldman Sachs shall CEASE AND DESIST from violating the Act or any regulation or order under the Act, and shall comply with Section 36b-31-6f(b) of the Regulations in connection with the marketing and sale of ARS.
4.
Within ten (10) days after the entry of this Consent Order by the Commissioner, Goldman Sachs shall pay to the “Treasurer, State of Connecticut”, by electronic funds transfer or wire transfer, the total sum of One Million Fourteen Thousand Nine Hundred Three and 35/100 Dollars ($1,014,903.35) as an administrative fine.
5.
If payment is not made by Goldman Sachs, or if Goldman Sachs 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 pursue any legal remedies, including but not limited to initiating an action to enforce the terms of this Consent Order, revoking Goldman Sachs’ registration under the Act or vacating this Consent Order.
6.
In the event another state securities regulator determines not to accept Goldman Sachs’ state settlement offer in connection with the multistate investigation referenced herein, the total amount of the Connecticut payment shall not be affected, and shall remain at One Million Fourteen Thousand Nine Hundred Three and 35/100 Dollars ($1,014,903.35).
7. 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 VIII.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 Goldman Sachs in connection with certain auction rate securities practices at Goldman Sachs.
8. Goldman, Sachs & Co. 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 Goldman, Sachs & Co. is obligated to pay pursuant to the foregoing Consent Order.
9. This Consent Order shall not disqualify Goldman Sachs 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.
10. To the extent applicable, this Consent Order waives any disqualification from relying upon the registration exemptions or registration safe harbor provisions that may be contained in the federal securities laws, the rules and regulations thereunder, the rules and regulations of self regulatory organization or any states’ or U.S. Territories’ securities laws.  In addition, this Consent Order is not intended to form the basis for any such disqualifications.  In addition, this Consent Order is not intended to form the basis of a statutory disqualification under Section 3(a)(39) of the Securities Exchange Act of 1934.
11. Except in an action by the Commissioner to enforce the obligations of Goldman Sachs in this Consent Order, this Consent Order may neither be deemed nor used as an admission of or evidence of any alleged fault, omission or liability of Goldman Sachs in any civil, criminal, arbitration or administrative proceeding in any court, administrative agency or tribunal.  For any person or entity not a party to this Consent Order, this Consent Order does not limit or create any private right against Goldman Sachs including, without limitation, with respect to the use of any e-mails or other documents of Goldman Sachs or of others concerning the marketing and/or sales of auction rate securities, limit or create liability of Goldman Sachs, or limit or create defenses of Goldman Sachs to any claims.
12. 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.
13. This Consent Order shall be binding upon Goldman Sachs and its successors and assigns, as well as upon 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 Goldman Sachs 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 Goldman Sachs 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 17th day of December 2010.      Howard F. Pitkin 
    Banking Commissioner 


CONSENT TO ENTRY OF ORDER

I, Michael Keats, state on behalf of Goldman, Sachs & Co., 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 Goldman, Sachs & Co.; that Goldman, Sachs & Co. agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that Goldman, Sachs & Co. voluntarily consents to the entry of this Consent Order, expressly waiving any right to a hearing on the matters described herein.     

 
Goldman, Sachs & Co.
  
           
By ______/s/_____________
Name: Michael C. Keats
Title: Managing Director

 
On this 16th day of December 2010, personally appeared [blank in original], signer of the foregoing Consent Order, who, being duly sworn, did acknowledge to me that he/she was authorized to execute the same on behalf of Goldman, Sachs & Co., a partnership, and acknowledged the same to be his/her free act and deed, before me.
 

______/s/_____________________
Notary Public
My Commission Expires: 1/14/2011
  

Administrative Orders and Settlements