[House Hearing, 110 Congress]
[From the U.S. Government Printing Office]


                        A REVIEW OF PROBLEMS AND

                         POTENTIAL RESOLUTIONS



                               BEFORE THE


                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION


                           SEPTEMBER 18, 2008


       Printed for the use of the Committee on Financial Services

                           Serial No. 110-140

45-624 PDF                  WASHINGTON : 2008
For sale by the Superintendent of Documents, U.S. Government Printing 
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Washington, DC 20402-0001


                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York         MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois          PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York         EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York           RON PAUL, Texas
BRAD SHERMAN, California             STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York           DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas                 WALTER B. JONES, Jr., North 
MICHAEL E. CAPUANO, Massachusetts        Carolina
RUBEN HINOJOSA, Texas                JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri              CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York           GARY G. MILLER, California
JOE BACA, California                 SHELLEY MOORE CAPITO, West 
STEPHEN F. LYNCH, Massachusetts          Virginia
BRAD MILLER, North Carolina          TOM FEENEY, Florida
DAVID SCOTT, Georgia                 JEB HENSARLING, Texas
AL GREEN, Texas                      SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri            GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois            J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin,               JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee             STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
BILL FOSTER, Illinois                KENNY MARCHANT, Texas
ANDRE CARSON, Indiana                THADDEUS G. McCOTTER, Michigan
JACKIE SPEIER, California            KEVIN McCARTHY, California
DON CAZAYOUX, Louisiana              DEAN HELLER, Nevada

        Jeanne M. Roslanowick, Staff Director and Chief Counsel

                            C O N T E N T S

Hearing held on:
    September 18, 2008...........................................     1
    September 18, 2008...........................................    59

                      Thursday, September 18, 2008

Adams, William IV, Executive Vice President, Nuveen Investments..    52
Coakley, Hon. Martha, Attorney General, Commonwealth of 
  Massachusetts..................................................    16
Galvin, Hon. William Francis, Secretary of State and Chief 
  Securities Regulator, The Commonwealth of Massachusetts........    13
Merrill, Susan, Executive Vice President and Chief of 
  Enforcement, Financial Industry Regulatory Authority...........    11
Norwood, Leslie, Managing Director and Associate General Counsel, 
  Securities Industry and Financial Markets Association..........    46
Payne, Tara, Vice President for Corporate Communications, New 
  Hampshire Higher Education Loan Corporation....................    48
Preston, James, President and Chief Executive Officer, 
  Pennsylvania Higher Education Assistance Agency................    54
Sherr, Roger, Vice President, Sherr Development Corporation......    50
Thomsen, Linda, Director, Division of Enforcement, U.S. 
  Securities and Exchange Commission.............................     9


Prepared statements:
    Adams, William IV............................................    60
    Coakley, Hon. Martha.........................................    80
    Galvin, Hon. William Francis.................................    85
    Merrill, Susan...............................................    97
    Norwood, Leslie..............................................   107
    Payne, Tara..................................................   123
    Preston, James...............................................   129
    Sherr, Roger.................................................   134
    Thomsen, Linda...............................................   137

              Additional Material Submitted for the Record

Frank, Hon. Barney:
    Written statement of the North American Securities 
      Administrators Association.................................   148
    Written statement of Professor Frank J. Parker...............   153
    Written statement of the Municipal Securities Rulemaking 
      Board......................................................   157
    Written statement of the Regional Bond Dealers Association...   178
Kanjorski, Hon. Paul:
    Responses to questions submitted to James Preston............   189
Miller, Hon. Gary:
    Letter to Hon. Melvin Watt from HUD, dated September 12, 2008   191
Perlmutter, Hon. Ed:
    CRS Report for Congress, Auction-Rate Securities, dated 
      September 17, 2008.........................................   192


45-624 PDF                  WASHINGTON : 2008
For sale by the Superintendent of Documents, U.S. Government Printing 
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Washington, DC 20402-0001

                        A REVIEW OF PROBLEMS AND

                         POTENTIAL RESOLUTIONS


                      Thursday, September 18, 2008

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10 a.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Maloney, Watt, 
Sherman, Hinojosa, Lynch, Scott, Green, Cleaver, Davis of 
Tennessee, Hodes, Klein, Perlmutter, Carson, Speier; Bachus, 
Royce, Jones, Shays, Capito, Neugebauer, and Campbell.
    Also present: Representative Shea-Porter.
    The Chairman. The hearing will come to order. I apologize 
for being a little late. Can we get the door closed back there?
    This is a very important hearing and I want to say I am 
very appreciative for the hard work of a number of people, 
including my two Massachusetts colleagues who are here, and the 
people from the regulatory field, but also people from the 
industry. We sometimes have a hearing to lament the bad state 
of affairs. Obviously, this is a situation where there have 
been problems.
    We rarely have hearings of self-congratulation, but I am 
pleased to note that the situation today regarding this looks a 
lot better than it did when we called the hearing; and, I am 
very appreciative of the efforts of a lot of people, as I said, 
including those who are here, who in leadership and industry 
responded. But it is still important for us to go ahead, 
because we have been focused, understandably as a Congress, in 
the Executive Branch and in the private sector on the important 
questions of systemic stability.
    No one thinks this country is falling apart, but we are 
undergoing a degree of stress now that is having negative 
consequences far beyond what we would like to see, and trying 
to cope with them and trying to put in place rules going 
forward that diminish the likelihood of a recurrence have been 
very important. There is a danger here, and I don't impute it 
to any one individual, but it is a danger for all of us. As you 
focus on systemic stability, investor protection can slip, 
partly because it is just not at the top of everybody's agenda, 
partly because there are in some cases conflicts. To the extent 
that you have institutions that have been weakened, it is a 
question of what compensation they give is going to be raised 
in some people's minds.
    Going forward, it is easier to make sure we do not allow 
these conflicts to arise, but I do believe that with regard to 
auction rate securities, there was a danger several months ago 
that investor protection was falling between the cracks, not 
outrunning the line decision to do it, but because other things 
were crowding it out, and because of some potential conflict in 
people's minds.
    I think through the efforts of a lot of people, and I think 
this committee was a part of it by frankly announcing the 
hearings and our staff working together to talk to people that 
we have helped elevate investor protection to where it should 
    There are a couple of issues about it, but with regard to 
investor protection, one thing in particular stands out in my 
mind that has changed some of what opinion had been; and, that 
is, we had previously taken a view, for instance with regard to 
hedge funds, that we had to protect the unsophisticated 
investor, but that for sophisticated investors, the principle 
of caveat emptor could prevail. We had a million-dollar cut-off 
of hedge funds, but the people who have been victimized in this 
include some very sophisticated investors, individual and 
    I think what it shows is we are in a world today where the 
complexity and opacity of financial instruments is such that 
you cannot say, oh well, if you have more than a million 
dollars you are on your own. I think this makes it clear that 
it's not enough to simply say, okay we'll just let everybody do 
what they want, and we just won't let you into it. We need to 
have the kind of regulatory system that among other things 
provide some safeguards, because as I said, some of the most 
sophisticated entities and investors have been involved in this 
and that means we have to broaden it. So I appreciate the 
participation of the witnesses.
    Our hearing is in part to figure out what has gone wrong. 
It is in part to encourage compensation, and I think we have 
made a lot of progress there and we will hear about that. I 
mean, what went wrong? How can we sort of compensate or see 
urged that people be compensated? Finally, and most importantly 
from this committee, what do we want to do going forward, 
because we will be adopting a set of regulatory rules going 
forward. What do we do to diminish the likelihood of this 
happening again?
    Now, that being the statement, I do want to make one other 
announcement not related to this hearing, and it has to do with 
what the role of the committee will be going forward. There is 
clearly a lot of interest in what has been going on with regard 
to the interventions that have come from the Executive Branch 
and the case of Fannie Mae and Freddie Mac authorized by us, 
and the cases of Bear Stearns and AIG done by the Executive 
Branch or the Federal Reserve. And I have had some requests 
about what are we going to do to look into it. This committee 
has a busy agenda.
    There is an overlap. I have had a meeting with Chairman 
Waxman of the Government Reform Committee; and, essentially, we 
have a kind of division of labor. That committee will be 
holding hearings under its jurisdiction, which is equal to us, 
as our friend from Connecticut, a very senior member of that 
committee knows. And it's always important to work out, I 
think, without friction, the authorizing committee and the 
oversight section; and, what we have agreed to is that this 
committee will continue to function on the policy issues, in 
particular on what going forward we ought to put in place to 
make these things less likely.
    The oversight committee, under its oversight function, will 
be looking into what happened, what didn't happen, and what 
should have happened. They will be looking at the actions of 
the private sector and the actions of the regulators. 
Obviously, those are not exclusively watertight compartments 
but that's where we are. So the thrust of the hearings into 
what happened and whether we are right or wrong are going to be 
going on the oversight committee.
    We will be talking about what is going to happen, moving 
forward. There is continuous contact, we hope will go on 
between the staffs from both parties and both sets of 
committees; and I knew there was some interest in that and 
that's where we are.
    With that, I will now call on the ranking member to make 
his opening statement.
    Mr. Bachus. Thank you, Mr. Chairman, for holding this 
hearing; and before I address auction rate securities, let me 
just say to Director Thomsen that I appreciate the action of 
the SEC yesterday. I think legitimate short-selling plays an 
important role in our capital markets, but what we have seen in 
the last year is abusive, naked selling.
    I think it has weakened a lot of our financial institutions 
that probably would have survived had it not been for those 
abusive practices, because as short-sellers often acting in 
concert with each other, systematically singled out one 
institution and drove down their stock, it undermined the 
confidence of the public and the customers of those 
institutions in the institutions.
    It impaired their ability to raise capital or to finance 
their debt and I think in many cases institutions fail; and, 
although it was not the root cause, the root cause of what we 
were facing today is years of over leveraging, risk-taking, 
over-extension of credit, failure of our rating agencies to 
properly regulate; and, in many cases, because of our outdated 
financial systems and inability in certain cases to regulate, 
or a patchwork or regulation where really no one was 
overseeing, for instance, the investment bank. But I will say 
that I believe with the action yesterday and the first action 
was taken it was limited to 19, I think, financial companies.
    I expressed at that time my concern that the short-sellers 
when that happened, went to some of the smaller, more mid-size 
banks and began concentrating on some of your smaller 
institutions; and, I think that what was needed then and what 
you have done yesterday was a blanket order. I have compared 
these packs of short-sellers to jackals, which have actually 
attacked financial institutions and brought them to their 
knees, and I think it has definitely worsened what we are going 
through today.
    In a conversation a year ago, Secretary Paulson told me 
that it was going to be almost impossible to avoid a painful 
deleveraging, because the chickens were coming home to roost--
many, many, because of failure to regulate--many, because the 
Congress didn't address problems which we had known existed, 
and that is across all Administrations and failure to modernize 
our system.
    But for whatever reason the industry, in many cases, 
resisted attempts to regulate. And they resisted very harshly. 
I was attacked across-the-board by the financial services 
industry when I proposed a subprime bill 3 years ago; and they 
went out and told the public. They told my colleagues that 
there was absolutely no problem in subprime lending and trying 
to regulate and impose some standards was going to make things 
    And a year-and-a-half ago, Chairman Frank and I referred to 
what we considered some dire straights that we were in and we 
were both criticized by our colleagues as exaggerating the 
situation they were in.
    The Chairman. More of your colleagues than mine.
    Mr. Bachus. What?
    The Chairman. I think it came more from your colleagues 
than mine.
    Mr. Bachus. There are quite a few.
    And another thing that the Congress didn't do at that time, 
there were things for instance that the chairman and I agreed 
on, but some of our colleagues wanted more. Some wanted less. 
And they would not agree to compromise; so we could not get 
anything done. And often, that is the situation. You always 
have folks who say they want to go further, people who say they 
don't want to do anything at all; and, what fails to happen is 
anything and that certainly happened. I think had it been left 
to he and I, we would have had a subprime lending bill 3 years 
ago. It wouldn't have been all that people have.
    I'm going to submit my remarks on auction rate securities 
as a matter for the record. Let me simply say with the auction 
rate securities, many of them were sold as being very liquid to 
investors. Cities, counties, they could get in, they could get 
out. It was a wonderful way to finance debt and it would always 
be liquid. Suddenly in February and March, they found that 
these assets were totally illiquid. It was almost like a roach 
motel, a financial roach motel. They could get in but they 
couldn't get out.
    It was a nightmare for our cities and counties and our 
States, and I am glad, because of some of the efforts of people 
in our first panel and others, and our announcement with Mr. 
Kanjorski that we were holding a hearing and an investigation, 
that a lot of that appears to be resolving itself, but as we 
deal with the stability of our financial markets, a large 
component of that is going to be the auction rate securities 
market, and I do believe that is one area where we are making 
real progress, and it is beginning to resolve itself. I think 
that will have positive implications for the economy.
    Thank you, Mr. Chairman.
    The Chairman. Before we get to the Orkin men and women on 
the panel, are there any other opening statements? I think the 
gentlewoman from New York has one?
    Mrs. Maloney. First of all, I want to thank the chairman 
for his leadership, not only on this issue today, but this has 
really been the most troubling time that I have ever seen on 
this committee. And I would say the markets have not seen such 
a turmoil in our country and I would say worldwide since the 
Great Depression. I strongly believe we should be looking like 
an RTC-like mechanism to take care of this crisis now.
    We cannot continue to approach it in a piecemeal way. We 
need a comprehensive approach. I would like to be associated 
with my colleague, the ranking member, and the chairman of the 
committee particularly on the naked shorts. Many people have 
called me and they believed that their company would be there, 
their jobs would be there, if this abusive practice had been 
stopped earlier, so I applaud the SEC's action and I feel that 
we should have a hearing and look in more to these naked 
    With regards to the auction rate securities market, we all 
have been following the situation since the market for these 
securities froze back in February. At its height, $160 billion 
worth of auction rate securities were issued by State and local 
governments, charities, and colleges and universities of all 
credit qualities and sizes. But, in February, everything just 
stopped. Since this time, everyone has been asking how these 
securities which were being marketed as something safe and as 
liquid and cash could have frozen all at once leaving $64 
billion worth of securities locked up.
    I have had constituents who have come to me, and they said 
they took out these securities. They said they could get their 
hands on it. It was as good as cash. They still cannot get 
their money back. Over the summer, we have seen settlements 
with the New York State and Massachusetts State attorneys 
general which would require banks to pay fines and buy back 
much of the $64 billion in frozen securities.
    While I applaud this effort, I still have concerns about 
the cost that the States, municipalities, and other public 
entities who were the issuers of these auction rate securities 
have been forced to incur; and, their liability, of course, 
then becomes a taxpayer liability. In a recent speech by former 
SEC Chairman Arthur Levitt, he made the following point about 
these issues, and I request unanimous consent to put his 
entire--and he really points to the need of more transparency--
and I quote from him as we try to unravel what happened.
    What becomes clear is that too many issuers were left in 
the dark. Many had no independent advisors; and those that did 
not hire advisors often found themselves receiving advice from 
parties that were conflicted since these advisors also worked 
as a banker in the auction securities market. He also reminds 
us that problems in this market have been known about for at 
least 4 years as a result of an SEC investigation into the 
broader market in 2004 and 2008, and that a lawsuit by the 
Massachusetts Secretary of State revealed that going back to 
2006, nearly 85 percent of the auction would have failed or 
produced different results without the single brokers' 
    At this hearing, I am particularly interested in learning 
exactly what happened and why it happened, and learning why 
exactly this market froze simultaneously in February, despite 
this market having problems and not functioning properly for 
many years. And why were these large penalty rates required for 
most issuers, but not required of the closed-end fund issuers 
or most structured bond issuers, though the securities were 
sold by the same underwriters to the same investors? So these 
are some of the questions to which I hope to hear answers 
    Again, I thank the chairman for having the hearing.
    The Chairman. The gentleman from Texas is recognized for 3 
    Mr. Neugebauer. I thank the chairman and I would ask that I 
could just revise and extend my remarks.
    The Chairman. All members will have general leave to put 
anything in the record they want.
    Mr. Neugebauer. I thank the chairman for having this 
hearing today because auction rate securities have played an 
important part of our market; and, particularly, I want to 
address my remarks primarily to the student loan program, 
because what has happened over the last year is one we passed 
legislation here where we reduced the amount of Federal subsidy 
to help some of the student loan securities be securitized in 
    And, at the same time, one of the major financing vehicles 
for student loans was affected by the fact that auction rate 
securities, and so I think what we are saying, and I applaud 
the chairman, I think this committee does need to focus on 
those things that we can do to get the markets back acting in a 
normal way again, because the sooner we can do that the better 
for all of the players. Unfortunately, some of the actions by 
some of the players that were not good actions, poor decisions 
were made as affected the entire market place; and our auction 
rate securities have played an important part for cities and 
particularly for entities that are financing student loans.
    We have been hearing from our bank friends all during the 
spring and summer their concerns about, because some of their 
traditional sources to be able to go with their student loans 
had basically dried up, because many of these entities, one of 
those in my district, has quit making student loans or quit 
purchasing student loans from banks until they can work through 
this, because quite honestly, right now, with the cost of 
financing or providing other financing vehicles for some of 
these loans just doesn't make economic sense for them.
    So I think as we hear from the panel today, one of the 
things that we need to hear is the way you think. I'm not a big 
market interventionist from the Federal Government. Maybe the 
best thing for us is to get out of the way and let the markets 
start functioning again. But, certainly, the sooner that they 
function, we start functioning more appropriately, obviously, 
the better for students and cities and other entities that have 
used these securities. You know, because one of the issues was 
that there are a lot of these entities.
    There wasn't the creditworthiness necessarily of those 
issues. It's just that once that pendulum started swinging 
there was a competence factor that spread throughout the 
market, and basically froze all of those auctions. And so 
raising the cost of financing for many of those entities, 
obviously providing some liquidity issues for people who 
thought that you could just get your money out of those at any 
time, and I think one of the underlying questions is you look 
into your crystal ball here.
    Do you see auction rate securities back in the market place 
    With that, I yield back my time.
    The Chairman. I thank the gentleman.
    The gentleman from Georgia for 3 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman.
    I'll be very brief. I hear a lot of discussion on the other 
side about getting out of the way and letting the markets take 
care of themselves. We have learned that is absolutely the 
wrong thing for us to do. If anything, we need to get in the 
way, and, we need to get in the way very quickly, because this 
is not just a problem in the United States anymore.
    This is a world-wide problem, and our prestige as a 
financial leader of the free world is at stake, the two 
underlining issues that we need to address very quickly is a 
decline in value of the dollar at home and abroad especially. 
But the other fact of the matter is where do you think we are 
getting this money? Where do you think we are going to get the 
money to bail out AIG, Bear Stearns, Fannie Mae, and Freddie 
Mac? It is not just being pulled off a tree.
    We are borrowing this money. Our debt is going out of the 
ceiling; and, where are we borrowing it from? Foreign nations 
and foreign governments at a rate that is really crippling the 
future of our financial stability in the world. So, Mr. 
Chairman, I just wanted to add my 2 cents to that, because this 
is a very urgent issue, and we need to get in the way very 
quickly and we need to find the appropriate vehicle to 
intervene, much like the ROTC that the chairman has talked 
about. As we responded to the savings and loan crisis of 1984, 
I believe, so this is a very serious issue. The one before us 
with the auction rate securities is especially, and I want us 
to deal with more detail as we get into this discussion today 
about the risk, the risk that is involved with the ARS market.
    We need to understand that. We need to know not only what 
is being done, but what can be done in the near future to 
address this collapse. Could more have been done to assess, to 
anticipate and further have prevented the auction rate mess?
    Were investment firms and broker-dealers well aware that 
the ARS market bubble was about to burst? There's a lot of 
culpability here--the nature of the recent settlements--the 
role of the auction manager. There's a lot we have to get in 
with this, but this is part of this bigger picture, and I think 
the climate in Washington needs to get very serious and get in 
the way and save our economy and the prestige of the United 
States as being the financial leader of the free world.
    Thank you, Mr. Chairman.
    The Chairman. The gentleman from Connecticut is recognized 
for 3 minutes.
    Mr. Shays. Thank you, Mr. Chairman.
    I first want to say that I think you are recognized by 
almost all the members here as being one of the smartest and 
the most effective. But I think the one are that you are not 
recognized, and I want to pay particular salute to it is that 
you have taken this issue, as you do so many others. Instead of 
trying to make it a political issue, have tried to say we have 
a huge issue; how do we come together. You have done a 
remarkable job, I think, of trying to get this committee to 
understand these problems and work together for the good of the 
country. And I just want to first thank you for that.
    The Chairman. Thank you.
    Mr. Shays. Secondly, I want to say that the smaller Federal 
family education loan providers, the FFELP providers, have 
utilized the auction rate securities market to raise capital to 
originate new loans. And so when this market froze, certain 
FFELP providers were unable to obviously access capital.
    On July 9th, I wrote to you and our ranking member, Mr. 
Bachus--I also appreciate the team that you have become--and 
said, let's have a hearing on this. So first, I want to thank 
you for doing this, for having this hearing. There's a lot 
about this process that I need to understand better. But what I 
do understand is that we have seen 19 of the top 100 lenders 
leave the Federal family education loan program entirely. And 
these totals include 14 nonprofit State loan agencies.
    I am told that three State loan agencies--Pennsylvania 
Higher Education Systems, the Massachusetts Education Finance 
Authority, and the Michigan Higher Education Student Loan 
Authority--suspended all FFELP originations. So every type of 
lender has been affected, 14 State loan agencies, 56 banks, 14 
credit unions, four nonprofit lenders, three school lenders, 
schools with 45 coming soon, and 34 non-loan banks.
    This is a very serious problem. One of our strengths as a 
country is that we have the best educated, best trained 
workforce. Our strength has still been particularly in higher 
education; and I remember when the government was almost shut 
down, the Clinton Administration and the Republican Majority in 
Congress. And I think I heard more from parents concerned their 
kids were not going to get their student loans and the programs 
would start to shut down.
    And it was interesting the number who were focused just on 
that issue. If we don't resolve this issue, we are going to 
hear from a lot of people and rightfully so.
    I yield back.
    The Chairman. I thank the gentleman. I thank him for his 
very gracious words, and the subject with the cooperation of 
most of the members of the committee that we have been able to 
do this, I would now put into the record under the general leaf 
a very thoughtful essay from Professor Frank Parker, who is a 
professor of real estate development at the Carroll School of 
Management, which is in the congressional district I represent, 
Boston College, and the State legislative district, the 
Secretary of the Commonwealth used to represent and lives near, 
but it's a very thoughtful article.
    And then, also, a written statement from the North American 
Securities Administrators Association; and, let me just say as 
we begin the testimony, we have had debates here from time to 
time over whether or not there should be a pre-emption at the 
Federal level of the role that the States play in securities 
law. And anyone who wanted some evidence that it would be a 
mistake to wipe out the State role or substantially diminish it 
can look at the history of this issue, because it has been at 
the State level that we have seen from my own State of 
Massachusetts, from New York and elsewhere, a degree of 
intervention, I believe, the State of Missouri, our colleague's 
sister from the State of Missouri, Ms. Conahan, that in a 
number of States it has been the State securities officials and 
law enforcement officials who have taken the lead.
    So I am pleased to put that statement in the record and 
they are entitled to say this is a strong affirmation of the 
need for that role.
    We will now begin with our panel, and will first hear from 
Linda Thomsen, the Director of the Division of Enforcement at 
the U.S. Securities and Exchange Commission.
    Ms. Thomsen.


    Ms. Thomsen. Good morning, Chairman Frank, Ranking Member 
Bachus, and members of the committee.
    I am Linda Thompson, the Director of the Division of 
Enforcement at the Securities and Exchange Commission. Thank 
you for the opportunity to testify today about the Commission's 
efforts in response to the freezing of the auction rate 
securities market in mid-February 2008.
    I have submitted my written testimony and asked that it be 
made a part of the record. I would like to start with the very 
big picture, and that is this: Thanks to the collective efforts 
of Federal, State, and SRO law enforcement and securities 
regulators, thousands and thousands of investors have billions 
and billions of dollars of liquidity restored to them in very 
short order. This relief is virtually unprecedented in type, 
magnitude, and timing. And due to these collective efforts, 
investors in auction rate securities at a number of firms, 
including retail customers, small businesses and charitable 
organizations will have the opportunity to receive quickly 100 
percent of the dollar investments.
    Customers who accept these offers will receive all of the 
interest payments or dividends they are due and will be given 
the opportunity to sell their auction rate securities without a 
loss. Since the auction rate securities market seized up in 
mid-February 2008, the need to restore liquidity for investors 
has been of paramount importance to the SEC and to our fellow 
    Through the Division of Enforcement, settlements in 
principle, with UBS, Citigroup, Wachovia, and Merrill Lynch, 
over $40 billion in liquidity will be made available to tens of 
thousands of customers. Auction rate securities were first 
developed in 1984, and as of 2008, it was estimated that the 
market had grown to $330 billion. Until mid-February 2008, 
auction failures were extremely rare and the market was highly 
liquid. For a variety of reasons, including the subprime 
mortgage and credit crisis that was unfolding throughout the 
second half of 2007, the auction rate securities market seized 
up in mid-February 2008 and the securities became illiquid.
    The SEC staff reacted immediately. The Division of 
Enforcement began investigating, and deployed tremendous 
resources to the effort. In March of 2008, enforcement staff 
began collecting detailed information from 26 broker-dealer 
firms. We interviewed investors and other market participants 
including employees of broker-dealers and issuers. We 
established a dedicated e-mail box to receive investor 
    Since mid-February, the Commission has received over 1,000 
complaints concerning approximately 50 broker-dealer firms. 
Investors reported that their brokers had led them to believe 
that they were investing in safe and liquid investments, cash 
equivalents. And when the market froze, they could not access 
their funds for important, short-term needs, such as a 
downpayment on a house, medical expenses, college tuition, 
taxes, and for some small businesses, payroll.
    To conduct investigations quickly and avoid unnecessary 
duplication, we also coordinated our efforts with other 
regulators including FINRA, the Office of the New York Attorney 
General, and the North American Securities Administrators 
Association and its membership, including, of course, the 
office of Secretary Galvin.
    The two largest auction rate securities market participants 
were Citigroup and UBS. These firms became the primary focus of 
the investigations being conducted by the SEC's enforcement 
staff and our fellow regulators. We were acutely aware that 
time was of the essence, and we expedited our efforts 
accordingly. In early summer, enforcement staff, along with our 
colleagues for the New York Attorney General's office, embarked 
on an aggressive schedule of taking testimony from employees of 
Citigroup and UBS.
    Our investigative record indicates that both firms made 
misrepresentations and omissions to their customers when 
marketing and selling auction rate securities. The SEC's 
investigation further shows that until the auction rate 
securities market seized Citigroup and UBS marketed auction 
rate securities as safe and highly liquid investments with 
characteristics similar to money market accounts, these firms 
misleadingly characterized auction rate securities as cash 
alternatives or money market and auction instruments. The firms 
failed to disclose, and in late 2007 and early 2008, auction 
rate securities liquidity risks had materially increased as the 
firms knew that there was an increased likelihood that they and 
other broker-dealers would no longer support the auctions.
    Early on, the SEC staff, in coordination with the New York 
Attorney General's office, took the lead in structuring, 
proposing, and negotiating the framework for a settlement that 
included liquidity solutions. This framework was developed in 
consultation with the SEC's Division of Trading and Markets and 
other Federal regulators in light of the potential impact on 
the broader capital markets.
    Of paramount importance was providing quick liquidity 
solutions for retail customers, charities, and small businesses 
that were from our perspective most in need of access to their 
funds. The agreements in principle with UBS and Citigroup 
established a general framework for other firm settlements. 
Other State regulators, especially through NASAA under the 
leadership of its President, Karen Tyler, and its auction rate 
securities taskforce, which included Secretary Galvin who 
provided tremendous leadership in this effort, quickly joined 
the efforts. And I should note that I believe it was Secretary 
Galvin who filed the first suit with respect to auction rate 
    Although negotiating global settlements was not easy, the 
State and Federal regulators proceeded in good faith, working 
virtually round-the-clock for weeks. All of us felt that 
working together enabled us to maximize the relief provided to 
investors. In early August, the SEC, the New York Attorney 
General's office, NASAA, and the Massachusetts and Texas 
securities authorities announced settlements in principle with 
Citigroup and UBS.
    In pertinent part, both firms agreed to offer to purchase 
frozen auction rate securities from retail customers, small 
businesses, and charitable organizations at 100 cents on the 
dollar. Both firms also made whole any losses sustained by 
customers who sold their auction rate securities at less than 
par after the market had frozen and both will offer no-cost-
loan programs to eligible customers with immediately liquidity 
    The settlements also provide a mechanism through FINRA for 
customers to participate in a special arbitration process to 
pursue consequential damages. As for larger institutional 
investors, UBS has agreed to offer to purchase auction rate 
securities at par over a longer timeframe, while Citigroup has 
agreed to use its best efforts to provide liquidity solutions 
for its institutional customers.
    The proposed settlements contemplate that the Commission 
will defer imposing financial penalties on the settling firms 
in order to evaluate, among other things, their performance 
under the settlements. The SEC staff is now finalizing the 
settlement terms with the firms which it will then recommend to 
the Commission for approval. In addition to the first 
settlements with UBS and Citigroup, the SEC staff and others 
have reached settlements in principle with Wachovia and Merrill 
Lynch. And our efforts are continuing.
    I would like to thank you for this opportunity to discuss 
the Commission's efforts with respect to the auction rate 
securities markets, and I would be happy to answer any 
    Thank you very much.
    [The prepared statement of Director Thomsen can be found on 
page 137 of the appendix.]
    The Chairman. Thank you for your testimony.
    We will now hear from Susan Merrill, the Executive Vice 
President and Chief of Enforcement at the Financial Industry 
Regulatory Authority, FINRA.


    Ms. Merrill. Chairman Frank, Ranking Member Bachus, and 
members of the committee, I am Susan Merrill, Chief of 
Enforcement at the Financial Industry Regulatory Authority, 
    On behalf of FINRA, I thank you for the opportunity to come 
and testify here today on these important issues. FINRA is the 
largest non-governmental regulator of the securities business 
in the United States. All told, FINRA oversees 5,000 brokerage 
firms and over 600,000 registered securities representatives.
    We at FINRA have been actively involved in working to 
resolve the issues relating to auction rate securities. From 
our exam staff to our enforcement team, from our arbitration 
forum to our investor education group, we have devoted staff 
from all parts of our organization to provide a comprehensive 
and integrated response to the recent challenges in the auction 
rate securities markets.
    Along with our regulatory counterparts, FINRA is committed 
to continue working on these important issues. We share this 
committee's interest in holding industry participants 
accountable and providing investors with real and tangible 
relief. Today, FINRA is announcing agreements in principle with 
five firms for violations regarding the manner in which these 
firms sold auction rate securities. The violations include 
using advertising and marketing materials that were not fair 
and reasonable and did not provide a sound basis for evaluating 
the facts regarding the purchase of auction rate securities.
    They also include supervisory violations relating to the 
firms' failures to achieve compliance with FINRA rules 
surrounding the sale of these products. Most importantly, in 
settling these cases, FINRA focused on restoring funds to 
customers. All of the firms involved in the settlements today 
have agreed to offer buy-backs of auction rate securities sold 
to their individual and small institutional investors. This 
will mean that over a billion dollars of auction rate 
securities will become liquid again.
    We at FINRA think that this is the right result. By 
expanding our scope beyond those firms that the SEC has rightly 
focused on, we have protected additional investors and restored 
funds to a broader span of customers. As for those firms who 
have not chosen to resolve their regulatory investigations and 
offer buy-backs of their customers' securities, we will 
continue to investigate these firms aggressively with a view to 
bringing enforcement actions where appropriate.
    The cases we announce today are the result of the work that 
FINRA has been doing since the market for these securities 
froze up and we began to receive complaints in February. FINRA 
immediately questioned more than 200 firms regarding their 
holdings in auction rate securities, both proprietary and 
customer accounts. We then used that information that we 
gathered in that survey to inform our next steps.
    After consulting with the SEC in order to avoid duplication 
of efforts, we sent out sweep letters in April to 2,000 firms. 
This summer, we sent out a second sweep letter to more than a 
dozen additional firms. Fifty-three FINRA staff members 
conducted on-site examinations of over 32 firms in more than a 
dozen States. On-site examinations are continuing as we sit 
here today. All told, FINRA enforcement is investigating over 
40 firms in connection with their marketing of auction rate 
    FINRA has also been active in issuing regulatory notices 
regarding auction rate securities. These notices provide 
guidance to firms on critical customer protection issues, 
including requiring firms to put customers' interests ahead of 
their own when allocating partial redemptions, and clarifying 
rules that allowed investors to sell auction rate securities at 
a discount if they wished to do so.
    In addition to our regulatory, examination, and enforcement 
initiatives, we at FINRA feel strongly that effective investor 
protection begins with education. That's why in March we 
published a comprehensive investor alert explaining in plain 
English what happens when auctions fail and what options are 
available to investors.
    In August, FINRA announced the establishment of special 
arbitration procedures for auction rate securities cases 
administered in our arbitration forum. Under these procedures, 
individuals who have worked for a firm that sold auction rate 
securities since January 2005 will not be eligible to serve as 
arbitrators. There are also special procedures for arbitrations 
filed pursuant to the regulatory settlements with the SEC and 
with FINRA. But it's important to note that the procedures I 
just outlined will be available to all auction rate securities 
investors, whether or not their firm has settled with the 
regulatory agency.
    In conclusion, FINRA has employed a comprehensive and 
integrated response to the recent challenges in the auction 
rate securities markets. FINRA will continue to aggressively 
pursue possible violations by firms and will continue to work 
with this committee and our regulatory counterparts to advance 
our essential investor protection mission.
    I thank you again for the opportunity to testify here 
today, and I would be happy to answer any of your questions.
    [The prepared statement of Ms. Merrill can be found on page 
97 of the appendix.]
    The Chairman. Thank you.
    And next, a securities administrator of the Secretary of 
the Commonwealth of Massachusetts, where we have the securities 
in his jurisdiction, who has been a real leader in efforts to 
provide protection here and is incidentally a former 
legislative colleague of myself, Mr. Markey, Mr. Delahunt, and 
Mr. Oliver.
    So we welcome him here, Mr. Galvin.


    Mr. Galvin. You left out Mr. Lynch.
    The Chairman. Were you gone by the time he got there?
    Mr. Galvin. No.
    The Chairman. Oh, you were hanging on longer than I 
    Mr. Galvin. Good morning.
    I am William Galvin, Secretary of State and chief 
securities regulator of the Commonwealth of Massachusetts. I 
want to commend Representatives Frank and Bachus for calling 
today's hearing to examine the causes of the failure of the 
market for auction rate securities and potential ways of making 
our regulation of the financial securities industry more 
    I am here today to discuss our findings and investigations 
into UBS and Merrill Lynch sales of auction rate securities. I 
feel compelled to say at the outset that there is a much larger 
issue here, and that is this: The auction rate securities 
scandal is just one more variation on a reoccurring theme that 
we have seen before. And that theme is the documented belief of 
large segments of the financial services industry that they are 
above the law, entitled to special privileges, entitled to 
engage in conflicts of interest, and have no duty or obligation 
to average investors.
    I am here to speak of the lessons learned from our 
investigations and to present proposals for preventing such 
problems. But I must say that without stricter regulation and 
sustained and diligent enforcement, this theme will again 
emerge. Specifically, five basic facts, I believe, arise from 
the auction rate debacle. They are: Conflicts of interest need 
to be more aggressively monitored and disclosed to investors; 
financial advisor incentives need to be disclosed; financial 
advisor training needs to be enhanced; supposedly objective 
research reports need to be more tightly regulated; and self-
regulation is not effective to prevent a scandal such as this 
one and that the State regulators, in conjunction with their 
Federal counterparts, need to continue to be actively involved 
in enforcement actions.
    I believe that the need to ask ourselves difficult 
questions about how we can make our regulatory scheme more 
effective is especially important given this week's market 
events. Government intervention is more effective when it 
monitors aggregate risk-taking and prevents bubbles from 
building instead of having to bail out the parties after the 
bubble has burst.
    In June of this year, my office filed an administrative 
complaint against UBS in conjunction with its marketing and 
sales of auction rate securities. The details of the 
allegations have been provided in my written testimony. 
Briefly, our investigation exposed a profound conflict of 
interest between UBS and its customers, and the devastating 
effect that this conflict had on those customers. It exposed 
how UBS was, unbeknownst to its customers, propping up its 
auction rate market and manipulating the interest rate at which 
the auctions cleared. It also exposed that as the auction rate 
markets became more risky, UBS increased its efforts to unload 
auction rate risk from its own balance sheets onto the accounts 
of its customers.
    In July of this year, my office filed an administrative 
complaint against Merrill Lynch. The complaint charged that the 
firm was implementing a sales and marketing scheme which 
significantly misstated the nature of auction rate securities 
and the overall stability of the auction market. The complaint 
also focused on the extent to which Merrill Lynch co-opted its 
supposedly independent research department to assist in sales 
efforts be it towards reducing its inventory of auction rate 
    Our goal has been that all investors stuck in auction rate 
securities will be made whole. My office as well as other 
regulators have entered into settlements with UBS, Merrill 
Lynch, Bank of America, and other underwriters and sellers of 
auction rate securities. In those settlements, the firms have 
agreed to repurchase tens of billions of dollars worth of these 
securities. Much work remains to be done.
    However, it is not too early to step back and attempt to 
draw lessons from this experience that might help us prevent 
such breakdowns from occurring in the future. The UBS and 
Merrill Lynch cases highlight the conflicts of interest that 
can arise between a broker-dealer and its customers. It became 
apparent that the broker was controlling the interest rates at 
which most of the auctions cleared. In doing so, the broker was 
beholden to its investment banking clients to whom it had 
promised low-cost financing, yet needed to raise interest rates 
just enough to be able to unload its own inventory onto 
unsuspecting clients.
    Prior to the market collapsing, when each firm made a big 
push to reduce its own holdings of auction rate securities, it 
did so by foisting those securities off on unsuspecting 
clients. These conflicts need to be aggressively monitored to 
determine whether they fundamentally impair a firm's ability to 
responsibly attend to its clients' needs. At a bare minimum, 
these conflicts need to be properly disclosed.
    Two other points which arose starkly in our investigations 
were the significant incentives to financial advisors to move 
auction rate products and the profound lack of training those 
advisors received with respect to those products and their 
attendant risks.
    Most investors assume that the financial advisor selecting 
financial products for them is indeed applying his or her 
professional expertise with the primary goal of choosing 
financial products that are most appropriate for that 
customer's particular circumstances. However, our 
investigations reveal that UBS and Merrill financial advisors 
receive substantial incentives unbeknownst to customers to sell 
auction rate securities.
    I believe that regulators should require a more 
comprehensive disclosure of the financial incentives that 
financial advisors receive. This would allow the consumer to 
better assess whether the advisor is selecting the product 
based on customer suitability or maximizing commission revenue.
    Another proposal that merits serious consideration is 
explicitly holding broker-dealer agents to a fiduciary standard 
of care with respect to their customers. Such a step is 
especially important given the increased complexity of 
financial products and increased dependence of customers on the 
advice of their financial advisors.
    The next point I would like to discuss is research reports. 
Five years ago, a number of securities firms including Merrill 
Lynch reached a settlement with regulators that was supposed to 
eradicate the conflicts of interest that pervaded Wall Street 
research and analysis. However, that settlement technically 
applied to only stock research and not to fixed income 
research. Merrill was quick to make this distinction in its 
statement following my division's filing its complaint.
    However, the principles underlying the settlement--that 
research reports presented to the public as being supposedly 
independent should not be tainted by undisclosed conflict of 
interest--have not been adhered to in this instance. As a 
result, more rigorous rules pertaining to research reports are 
necessary. I believe the overnight disappearance of the $330 
billion market for auction rate securities should give pause to 
those who think that markets can effectively police themselves.
    If the free market is to be truly free and survive, it must 
be saved from its own greed and its repeated willingness to 
deceive and dissemble in the name of higher profits. The 
conflicts of interest raised here stand in stark contrast to 
the idea that market participants guided by principles such as 
FINRA rule 2110 which imposes high standards of commercial 
honor will simply follow those principles and do not need more 
detail regulation.
    It is difficult to imagine that off-loading a known and 
worrisome risk of auction rate failure off a firm's own balance 
sheet and onto its customers holdings is consistent with high 
standards of commercial honor. I believe that a move in the 
direction of principle-based regulation at the expense of 
detailed and enforceable rules would simply open the door for 
more misconduct. This point is especially important given this 
week's market events.
    The Chairman. We are going to have to wrap this up.
    Mr. Galvin. I would conclude, Mr. Chairman, by saying that 
I think we are clearly at the point in time where the entire 
market regulatory scheme is going to have to be reviewed and I 
would urge this Congress and the next Administration to do so 
with a view towards rewriting the entire system.
    I think this episode that we are here today discussing 
demonstrates the failure of that system, and I would hope that 
when it is rewritten, it is written in such a way as to protect 
investors first. That should be the first goal of any financial 
regulatory system.
    I will be happy to answer any additional questions.
    [The prepared statement of Mr. Galvin can be found on page 
85 of the appendix.]
    The Chairman. Thank you.
    Next, another State official who has been very active in 
the consumer protection field, the Attorney General of 
Massachusetts, Martha Coakley.


    Ms. Coakley. Thank you, Chairman Frank, Ranking Member 
Bachus, and members of the committee. I, like Secretary of 
State Galvin, am pleased to be here today. I appreciate the 
invitation. I am the Attorney General for Massachusetts and our 
office shares some responsibility with the Secretary of State 
for public enforcement for securities laws at the State level 
of Massachusetts.
    Our office, as in most States, is authorized to bring 
criminal and civil actions in our State courts against 
investment banks, brokers, and issuers who deceive investors or 
fail to meet required legal standards.
    Our office also has exclusive authority to bring actions 
under our State False Claims Act against entities that mislead 
towns, cities, and other State entities regarding investment 
    Auction rate securities sold in Massachusetts have been a 
great concern to us, and although these securities have long-
term maturities for many years, they have historically been 
offered for sale at weekly or monthly auctions, which provided, 
and I stress, the appearance of periodic liquidity. My 
colleagues on this panel have discussed that.
    That is one of the major issues for us in looking at these, 
was the appearance of liquidity. Because of the supposed 
liquidity, auction rate securities were touted as being cash 
alternatives and, when earlier this year the market for auction 
rate securities dried up, the auctions through which they were 
sold experienced widespread failures, eliminating liquidity and 
making it difficult to dispose of the securities at all, much 
of which has been evidenced by my colleagues here today.
    When the securities were written down to reflect the 
reduced market value, many investors suffered serious losses in 
their investment principal.
    In early 2008, Secretary of State William Galvin talked 
with our office and he requested that our offices divide 
responsibility and, frankly, our Attorney General's office 
concentrated just on the sales to towns, cities, and State 
entities and focused on whether State entities as customers 
were misled regarding the appropriateness of auction rate 
securities as investments.
    We served investigative subpoenas. We met with affected 
municipalities. We reviewed documents and we took testimony 
from investment banks and their agents. We carefully 
scrutinized broker behavior, disclosures, as well as the lack 
of disclosure, as we had done in the predatory lending market 
and the behavior of investment banks as they sought to transfer 
auction rate securities from their own accounts to those of 
their customers.
    Six weeks after starting our review of the investments of 
Springfield, Massachusetts, and days before the broader market 
for auction rate securities began to melt down, we recovered 
from Merrill Lynch at par, the $14 million that Springfield had 
invested in auction rate securities.
    We initiated our review of UBS on the same day. The UBS 
began letting its auctions fail and we completed that 
investigation in 10 weeks. There we recovered over $37 million 
for 18 Massachusetts municipalities and State entities. We 
began our review of Morgan Stanley in the same timeframe, which 
resulted in the recovery of an additional $2 million for cities 
and towns. And finally, last Friday, our ongoing review of 
Citibank resulted in Citi's agreement to return $20 million to 
the Massachusetts Water Pollution Abatement Trust.
    Our recovery against Merrill was the first recovery by a 
State in the auction rate arena and our consent judgment 
against UBS was the first court-ordered resolution by a public 
    We believe that our early investigations and litigation 
efforts helped jump start the broader resolution process and we 
commend the terrific work of Secretary Galvin, the SEC, and 
FINRA, and other regulators in other States for the roles they 
played in moving the larger process forward.
    Let me make three quick recommendations. First, any 
solutions reached should actually return full investment 
amounts to all investors. We talked today about agreements to 
repay. I think it is really important that payments, in fact, 
be made. Second, that those be made extremely promptly; and 
third that nonprofit and governmental issuers should not be 
forced to incur additional expenses and losses as a result of 
    In addition, the committee should not overlook the problems 
with the underlying assets backing some of these securities, 
and we have submitted testimony for yesterday's hearings 
relating to our work around the predatory lending in the 
subprime market and how that has affected Massachusetts and how 
we, frankly, have not seen any restructuring of transactions to 
be successful.
    I think that as we have stressed the restitution and having 
it quickly is important, and our emphasis obviously in State 
government is for our government entities and our nonprofit 
entities mentioned by members of the committee earlier, 
particularly around the student loans.
    Finally, even if the committee is able to resolve the 
immediate auction rate problem, as Secretary Galvin has noted, 
we still need to consider the stability of the underlying 
assets that back these notes.
    We should be careful to ensure that intermittent liquidity 
crises in financial markets do not disproportionately harm 
    We appreciate the chance to talk to you today. We are happy 
to answer questions, and more importantly, are happy to work 
with you as you look at further solutions and other 
    [The prepared statement of Attorney General Coakley can be 
found on page 80 of the appendix.]
    The Chairman. Thank you. When we began, Ms. Merrill, you 
mentioned that there were five settlements recently reached. I 
am struck by the coincidence of those individuals, those 
entities, being willing to sign those agreements on this. Can 
you tell us who they are? I assume it would be appropriate to 
know who they are.
    Ms. Merrill. Absolutely. The names of the five firms that 
have settled with us today--the agreements in principle were 
reached last night and we are announcing them this morning--
are: SunTrust Robinson-Humphrey; SunTrust Investment Services; 
Comerica Securities, Inc.; First Southwest Company; and WaMu 
Investments, Inc.
    The Chairman. Thank you. I have a couple of questions. This 
is one that gets us to another topic, but Secretary Galvin, in 
an earlier point, was one of those who called to my attention 
problems with the arbitration procedures, and I believe we had 
a hearing on this, that the individual one-time investor, or 
investor engaged in a one-time arbitration, is at something of 
an institutional disadvantage.
    I was pleased that you mentioned some special rules, but my 
question would be, if those are good rules for this why keep 
them special? Why not make those rules for arbitration in 
general in these situations?
    Ms. Merrill. That is a good question. We had a rule that 
covers exactly how our panels are constructed for arbitration. 
It would require a rule filing, which would take a good bit of 
time to get through the approval process, and so we wanted to 
quickly do it for this.
    The Chairman. Your intention would be to carry that out for 
other things as well?
    Ms. Merrill. What we are doing in terms of our broader 
arbitration forum is, right now we have announced a pilot 
program with 10 firms that have agreed to use a pilot program 
for a specified number of cases for 2 years where investors can 
choose a non-public arbitrator or an all-public panel.
    Once we see the results of that pilot program we will 
certainly look at expanding our rule to make that across-the-
board, but we are very pleased that the firms have stepped up 
and agreed to the pilot program.
    The Chairman. All right, well, we will get back to that. I 
don't want to not raise it, but that is important.
    Let me go back to a point that Secretary Galvin raised and 
that is the principles versus the rules, and I understand the 
desire of many in our country to say, well, we like more 
    But here is the dilemma that we confront. In a number of 
cases when people raise objections to certain behaviors, the 
defense is, well, it wasn't prohibited. That is, people need to 
understand if they are going to use the absence of a specific 
in hoc prohibition as a permission to do something, then the 
case for more flexibility is undercut.
    And I say that because people say, well, we want principles 
and not rules. I don't know the exact rules that were involved 
here, and in some cases it would seem to be there were rules 
probably broken. But I can't imagine that in principle people 
do not understand this is the wrong thing to do given what has 
been described.
    So I ask the Secretary of State this: Is this an example, 
frankly, of people taking advantage of an absence of 
specificity and a case where principles that we would have 
assumed were pretty generally subscribed to didn't serve as an 
adequate defense?
    Mr. Galvin. Well, clearly I think that is the case if that 
were all we had to rely on. In the cases that we brought in 
Massachusetts, we alleged that there was fraud on the part of 
the two cases that we actually brought and we were still 
investigating some of the others.
    But I think the absence of detailed rules, the absence of a 
requirement for our financial advisors to be looking at the 
financial suitability of certain investments, those are clearly 
demonstrated by the situation.
    Many of the people who called my office, as you have heard 
from some of the other witnesses this morning, were 
specifically told that these were ``cash-like instruments.'' 
They were promised liquidity. They were led to believe, not 
only because of past practice, but because of what was 
specifically said to them, that they would have no difficulty 
getting their money out and that obviously was not accurate; 
and was particularly sinister when there were firms that knew 
these things were going down and specifically had made a 
decision at some point no longer to support them. And that is 
what we maintained in our complaints.
    I think it clearly requires more specific rules, and as I 
attempted to point out, I think it is a broader issue than just 
this particular type of--
    The Chairman. The next question is for Director Thomsen. We 
have had questions in the past. Am I correct in inferring that 
this seems to be a case where there was reasonably good 
cooperation between the Federal regulator on the one end and 
the State regulators, and this is an example of how we might be 
pulling resources to the common good?
    Ms. Thomsen. I think this is an example of terrific 
cooperation on all our parts and I should jump in right now to 
congratulate FINRA on the recent cases.
    But when you step back and think about this, the problem 
really arose in dramatic fashion in February of this year and 
through the efforts of everyone here, State regulators, Federal 
regulators, FINRA, we have reached a solution for retail 
investors in very short order that gets them 100 percent 
liquidity back and we have worked together to get that. It is 
really an exceptional result and it does reflect all of us 
working together, I think, quite well.
    The Chairman. Thank you. I have to step out for a little 
bit and Ms. Waters will preside. I will be returning.
    Ms. Waters. [presiding] Thank you very much.
    Mr. Bachus, our ranking member, for 5 minutes.
    Mr. Bachus. Thank you. Director Thomsen, what is the status 
of the Commission's examinations that were announced July the 
13th to examine the controls against manipulation against 
security prices through the intentional spreading of false 
    Ms. Thomsen. Well, let me talk generally about where we 
stand with respect to that, the concern about spreading false 
rumors. As you pointed out in your opening statement, if people 
are engaged in spreading false rumors, driving stock prices 
down, that conduct is reprehensible. It is also illegal.
    Mr. Bachus. Pull the microphone a little closer to you. 
That is good.
    Ms. Thomsen. Over the past several days, as you have noted, 
we have increased our efforts and our tools. As you may know, 
earlier this year, a few months ago, we brought our first case 
against someone for spreading a false rumor. It was the 
Berliner case. It was brought shortly after Bear Sterns 
    We have been investigating aggressively, and as of 12:01 
this morning, new rules went into place to put further controls 
on abusive short selling, naked short selling.
    Last night we announced that the commission is going to be 
requiring reporting of short positions by large investors, 
which will help in both transparency and in law enforcement 
and, as you know, as part of last night's announcement, I made 
clear that the Enforcement Division will be pursuing these 
issues with a vengeance.
    Mr. Bachus. How quickly will the SEC be able to detect 
whether illegal trading or manipulation through illegal short 
selling is going on?
    Ms. Thomsen. I am not going to lie to you. These are 
difficult, difficult investigations. It is going to require 
lots of hard work, but we are deploying lots of resources to 
get there.
    We will follow the evidence as quickly as we can and if 
there is evidence we will bring those cases as quickly as we 
can. We want to make sure if we bring those cases we have the 
evidence to sustain the action because, as I say, I think the 
behavior, if it can be established, is reprehensible and as I 
said, it is illegal.
    Mr. Bachus. Let me ask this question to FINRA and Ms. 
Merrill. The current broker licensing examination doesn't have 
a single question on auction rate securities. Is that an 
omission and should questions be asked of financial 
professionals, people who want to be in this regard?
    Ms. Merrill. Well, I think your question highlights an 
issue with auction rate securities that we are looking at 
internally at FINRA, and that is something that we look at on a 
risk-based basis.
    We saw the securities as relatively low risk. Certainly on 
an examination for a registered representative, you can't ask 
about every product that a rep can sell, and so this one may 
not have risen to the level.
    But now as we look back at this, we can see that there may 
not have been such default risk, but certainly there was 
liquidity risk, and since that is the way this product has 
really been marketed, as liquid, that is what we really need to 
go back and examine.
    Mr. Bachus. Are you all going back and looking when you 
train those who are going to market financial products and 
license them, whether there are other areas other than maybe 
auction rate securities where they simply don't have the 
expertise to market certain things; they don't disclose things 
because they may not know?
    Ms. Merrill. Training is so important. Firms are 
responsible for training their registered representatives, of 
course well beyond the licensing, the initial Series 7 test. 
And what we found when we went out and interviewed the brokers 
who are actually on the phones and talking with investors is 
that many of them did not appreciate the liquidity risk. They 
didn't understand the auction, and that is a failure of the 
firms to train their reps.
    Mr. Bachus. Okay, thank you. And that is with today's 
announcement that 16 firms that have made agreements. You still 
have about 35 now with the smaller firms, but some of the main 
street firms or regional firms, are you making a lot of 
progress with the other 35 firms?
    Ms. Merrill. Yes, most of the firms, in fact, that we are 
looking at are the smaller, downstream firms. The issues there 
are different from the cases that have been brought by 
Secretary Galvin and by the SEC and other members of NASAA 
insofar as these are really not fraud cases, but we do believe 
that every broker-dealer has the responsibility to be marketing 
the product fairly; and they may say that they didn't know that 
there were cracks in the auction rate system, but the way they 
market, the types of disclosures that they make have to be fair 
and balanced.
    So we have made progress with the firms that we are looking 
at. We will continue to look to see if there have been rule 
violations, particularly the advertising and supervision rules. 
Where we find those violations we are going to apply pressure 
on these firms to do the buy-backs.
    Mr. Bachus. Thank you. I want to commend the Attorney 
General and Secretary of State of Massachusetts. I think your 
efforts have led to some recoveries in other States. I think 
you benefitted people not only in your home State, but across 
the United States, with some of your investigations.
    Ms. Waters. Thank you very much. I will recognize myself 
for 5 minutes, and I would first like to begin by 
congratulating and commending all of you for the work that you 
have done in helping to make sure that the investors are made 
whole, that they are taken care of.
    That is good work and I have a real appreciation for that, 
but I would like to continue a little bit, my questioning, to 
ask about what I would consider preemptive work, or the kind of 
work that regulatory agencies do that avoid the problems in the 
first place.
    And, of course, as we have entered this very difficult 
economic period, our own regulatory agencies that we are 
dealing with, not just with SEC, but as we are taking a look at 
what we are confronted with now, we are wondering what can be 
    What can be done to identify, to be able to determine 
through auditing, when these problems are beginning to surface? 
Do we have to wait until we hear from investors who are now 
screaming and calling and accusing and very, very worried and 
very scared that they are going to lose everything? What can we 
do? What can you do to prevent--and let me start with the SEC--
I know you are Enforcement, but what can be done before?
    Ms. Thomsen. Well, thank you very much, and it is a very 
important question. To a certain extent there is a part of me 
that thinks when Enforcement gets involved, we have already 
missed some opportunities and we would like not to miss those 
    But as Secretary Galvin noted, we are not so naive as to 
believe that we are not going to be necessary in some 
instances. I think as we have talked about, the problem here is 
largely one of sales practice; and that is an important issue 
to address.
    It is important for all of us to focus on the training of 
sales reps and registered representatives who interact with 
customers, especially retail customers, to make sure they 
understand the products that they are selling. So that is one 
thing that we can focus on and that the firms can focus on. It 
can surely be something that we focus on during our 
    It is also the case, as Secretary Galvin noted, that many 
of the issues that arise in the securities field arise due to 
conflicts of interest. It has been noted oftentimes in the past 
that we cannot eliminate those conflicts, but we can disclose 
them, we can manage them, and we can train around them.
    I think one of the things that has been most dramatic here 
as we have dug into the facts is to see how little various 
registered representatives understood about the products that 
they were selling to their customers.
    We also do need to be alert to changes in markets and think 
about what we do when those changes occur. Secretary Galvin 
noted that in some instances compensation was increased to 
encourage the sales of products.
    I think that is one thing we can look for in examinations 
because that may change the incentives. We need to look at 
compensation structures, but it is also something firms can be 
alert to as they change their compensation practices to think 
about why they are doing it and what does that mean from a 
conflicts perspective.
    Ms. Waters. Let me just ask Ms. Merrill, in keeping with 
this conversation, discuss criminal penalties with me. What are 
the penalties?
    We discovered in the subprime meltdown that, for example, 
in California there were two ways that real estate loan 
initiators could sell the products on the street. One was they 
could go through a licensing operation that we have; or the 
company, such as Countrywide, who is licensed, could then hire 
a salesperson who did not have to go through the licensing 
examinations, and they put them on the street; and we are 
finding that not only did a lot of our citizens and consumers 
get seduced into products that they did not understand, but 
perhaps the salesperson didn't understand them or 
misrepresented knowing that these ARMs and these other very 
exotic products were going to place these people at risk.
    So let's talk about penalties. What should the penalties 
be? What are they?
    Ms. Merrill. In FINRA, our penalties in auction rate cases 
and our whole settlement structure has been focused on getting 
money back to investors. As I mentioned, the firms that we have 
been focusing on are primarily the smaller, downstream firms 
where we have not seen evidence of fraud. So without evidence 
of fraud, where we are enforcing our advertising rules and our 
supervision rules, we focus primarily on the remedy to 
    We do have fines associated with our cases today as high as 
$1.65 million down to about $250,000. Those fines are meant to 
give those firms credit for the fact that they stepped up and 
bought back these securities from their investors, and that has 
really been our motivation.
    The question that you asked before about what we can do to 
make sure this doesn't happen again, I assure you is a question 
that we have been asking ourselves internally at FINRA.
    We have a group called the Emerging Issues group. We try to 
stay ahead of the curve on emerging issues. We talk to member 
firms. We talk to customers to find out how things are being 
marketed to them. We read the academic journals to see what is 
on the horizon and we are very concerned not only about the 
cases that we have brought today, but what other kinds of 
products are being marketed as cash alternatives or cash 
equivalents. Are they really cash equivalents and is the way 
these other types of products being marketed fair and balanced?
    Ms. Waters. Thank you very much. Mr. Shays for 5 minutes.
    Mr. Shays. I am pretty convinced that those who were 
marketing these in a way that didn't represent an accurate 
picture are going to pay a penalty, and I am pretty content 
that fact has been established.
    What I am interested to know is, and I guess I would ask 
the SEC, are auction rate securities going to disappear? Are 
they the same for the corporate, the student, and the muni? I 
mean, what is going to survive here?
    And then I would like to ask the State folks if they had 
any sense, is the State out of the picture in terms of student 
loans right now? I am really concerned about student loans and 
I hope I get something from this hearing that has me feeling 
somewhat hopeful; and if not hopeful, at least a realistic 
picture of what is happening.
    Ms. Thomsen. Thank you. It is an excellent and difficult 
question. First, to start where you started and to reiterate 
some of the things that have already been talked about, yes, 
the individuals who have been involved in bad behavior will be 
pursued. We have not yet brought individual cases, but we 
continue to pursue them. We will bring remedies against them to 
the extent we can establish cases. And that will also serve a 
deterrent purpose and help us avoid things in the future.
    As to the future of the auction rate securities markets, I 
think right now it is a difficult time for anyone to try to 
raise capital through an auction rate securities process in 
part because of the failures that have been demonstrated in 
this market.
    You would have a very difficult time suggesting to an 
investor that these securities are liquid against the current--
the freezing up in February. So I think it is fair to say that 
raising capital through an auction rate securities process is 
difficult right now.
    Mr. Shays. In all three areas: Municipal; corporate; and 
    Ms. Thomsen. I believe in all three, and I have to say that 
I believe that student loans are the most difficult because of 
the interest caps that are associated with student loan auction 
rate securities.
    Now on the good news front, to the extent there is some 
good news in all this, there is liquidity that is being 
restored to these markets, in certain instances, even in, to a 
limited extent, the student loan market. And people are engaged 
in some refinancing and whatnot, but I think the product itself 
is going to have to change--if it is going to be marketed as a 
liquid investment, that development's to assure that liquidity 
are going to--
    Mr. Shays. And we are really talking, this is impacting the 
State loans student loans, not the Federal. Can either of you--
    Mr. Galvin. I think it has primarily affected student loan 
authorities, which many States have established.
    I can tell you that in Massachusetts, the Massachusetts 
Educational Loan Association had suspended loans back in July 
causing great difficulty. Fortunately just yesterday or the day 
before, they were able to announce that they have secured some 
    I think the general point regarding auction rates is 
probably true, that I think not just because of the bad press, 
if you will, associated with auction rate, but the whole 
concept of this auction has been discredited because the 
auction was, in many respects, a fantasy; it never really 
    Mr. Shays. Right.
    Mr. Galvin. I think the bigger issue as far as financing 
educational funds is going to have to be approached from a 
number of different ways.
    One way possibly is to have States, which was not the case 
specifically in Massachusetts but was suggested, have the 
States behind it with their State credit to verify for the 
authority to be able to go out and solicit some sort of 
    Others have suggested, and I found this an appealing 
thought, I suppose it wouldn't apply for everybody, but that 
some of the large endowments of educational institutions ought 
to be sought out to be invested to support these funds. Many 
educational institutions enjoy very large endowments. I know in 
my State, and I believe in yours, they may well also be a 
source. I mean, these endowments--
    Mr. Shays. Right. The bottom line is, though, you agree. 
This is an issue that we have to pay--
    Mr. Galvin. Yes, I would certainly agree. I think that for 
many students right now this is a critical time--
    Mr. Shays. I just want to ask one last question and it is a 
real curiosity to me. If this has been an instrument for 24 
years, has false advertising occurred all throughout 24 years?
    Mr. Galvin. I rather doubt it. I can't answer you 
decisively, but I believe that it became a practice, and 
because these instruments were successful for so many years and 
they worked for different consumers, they worked for the 
institutions who were trying to get some advantage to their 
debt, they worked for individuals who were looking for a 
slightly better rate. They did work, and as a result of the 
credit freeze-up as a result of the market starting to fall 
apart, they, indeed, became inoperative.
    What we became involved in, and I think it has already been 
referred to here by myself and others, is that at some point 
the market makers became aware of that and instead of dealing 
with it in an upfront way, they went ahead and deceived people.
    Mr. Shays. Yes, that point was made, I'm sorry. I 
appreciate you emphasizing it. Thank you all. Thank you, Madam 
    Ms. Waters. Thank you. Mrs. Maloney, for 5 minutes.
    Mrs. Maloney. Thank you very much and I thank all of the 
panelists. I would like to ask Ms. Thomsen and the SEC, when 
you censured in 2006, why did you not impose transparency in 
the auctions then? As I understand it, there was an 
investigation in 2004. Why did you not require disclosure just 
like the U.S. Treasury does on all of its auctions?
    Ms. Thomsen. Thank you for that question, and indeed there 
was a requirement of disclosure at that time. The investigation 
into auction rates that resulted in the actions in 2006 focused 
    Mrs. Maloney. Excuse me, there was a disclosure 
requirement, a transparency requirement in 2004?
    Ms. Thomsen. In 2006 as a result of--
    Mrs. Maloney. Can the committee get a copy of that?
    Ms. Thomsen. Oh, sure.
    Mrs. Maloney. Did it talk about the fees and the fact that 
it is not cash and that it is really a hazard for people to get 
    Ms. Thomsen. Excuse me, I misunderstood. The disclosure 
that was required in 2006 and the investigation that led up to 
the cases in 2006 had to do with how the auctions were 
conducted and the way the firms conducted the auctions, which 
included the fact that the firms went into those auctions and 
in some cases sort of gamed the system to get the price sort of 
in the ``sweet spot,'' if you will.
    Mrs. Maloney. So you were looking at how the firms were 
gaming the system. Was there any disclosure or transparency 
that was given to issuers and investors to tell them about the 
risks? My constituents told me that they were told, ``This is 
as good as cash,'' then they found out they couldn't get their 
cash. So they feel they were manipulated or treated criminally. 
And I just want to know, do we have any transparency now 
letting buyers know about the risks that are involved, and if 
not, why don't we start SEC rulemaking immediately so that this 
type of scam doesn't continue?
    Ms. Thomsen. There are certain kinds of disclosures that 
are associated with this, and there are certain disclosures 
that did not go to investors, as we have talked about. The 
investors, as a result of our action in 2006, for the firms who 
were part of that process, are given disclosure or have the 
opportunity to see disclosure about how the auctions operate.
    Mrs. Maloney. Are they told that it is not cash? I am told 
they were told it was as good as cash. It is not. Is your 
transparency telling them how risky it is, how many billions of 
dollars have been lost, how taxpayers have been hurt, how 
localities have been hurt? Are you disclosing that, and if not, 
why are you not disclosing that now in the billions of auctions 
that are currently being conducted each day?
    Ms. Thomsen. I think it is fair to say that as a result of 
this investigation and focusing on the sales practices, it is 
clear that investors were not told about the potential 
liquidity risk and--
    Mrs. Maloney. Are you telling them now?
    Ms. Thomsen. Well, right now there is no requirement for 
paper disclosure or written disclosure with respect to this. 
Indeed, most of the--
    Mrs. Maloney. Why not? We know that millions and millions 
of dollars have been lost, there have been two suits settled, 
and we know that--
    And I want to bring into this and congratulate the State of 
Massachusetts for your 2008 lawsuit where the Secretary of 
State--I find this astonishing, really astonishing--the 
Secretary of State revealed that going back to 2006, nearly 85 
percent of the auctions would have failed or produced different 
results without the single brokers intervention. So what are we 
doing to stop this conflict of interest?
    And the SEC, I have to tell you, I have constituents who 
have lost their jobs, they tell me, because the SEC didn't act 
quickly enough to stop the naked shorts. I am glad that you 
have finally stopped it, maybe it can save some other firms. 
But we know about this scandal now, and why are we not telling 
clients and individuals and investors and issuers about this 
horror that it is not cash, they can lose all their money, they 
will not get their hands on the money, not to mention the 
taxpayers who are supporting these institutions that go into 
them, they are not being made whole.
    So a lot of people are losing in this, and I think they 
should be told. Why aren't we telling them?
    Ms. Thomsen. The disclosure obligation is on those who are 
selling the product and it is a secondary sale, by and large--
    Mrs. Maloney. Well, why aren't you requiring them to tell 
the innocent people who are being lied to? You are telling me 
they were lied to. Why don't we get an SEC rule in tomorrow 
that says don't lie to investors and to consumers, let them 
know that it is not cash, that they can lose their money, and 
that there have been two lawsuits. Why are we going to 
    We are in a financial crisis. We cannot continue financial 
practices that lose money, hurt communities, hurt consumers, 
and hurt investors.
    Ms. Waters. Mrs. Maloney, let us hear her--
    Mrs. Maloney. My time has expired.
    Ms. Waters. No, we want to hear a response in your time. 
You asked questions that have not been answered yet.
    Ms. Thomsen. We do have rules, and in fact the fact that we 
are able to bring the cases that we are bringing right now 
demonstrates that registered reps cannot lie to their clients, 
they cannot tell them false information, they cannot represent 
something to be liquid that isn't, and that is what we are 
doing with our law enforcement efforts here.
    Mrs. Maloney. I would like a point of clarification in 
writing. Constituents are telling me that they are being told 
that they can get their cash back, but the State of 
Massachusetts went to court over this, that they can't get 
their cash back. Some of them, to this day, can't get their 
cash back. So are we clearly telling people in the disclosure 
that this is not cash, that you can lose your money? If you 
could just get back to us in writing exactly what you are 
    Ms. Thomsen. Oh, sure. But the actions here, what happened 
was people were told information that was false, and that is 
why we are bringing the actions that we are bringing, and that 
is why we were able to get the resolutions we were getting. But 
you are absolutely right, investors should not be lied to, and 
brokers and registered reps who lie to them should be 
accountable for those lies.
    Ms. Waters. Thank you very much. Mr. Neugebauer.
    Mr. Neugebauer. Thank you. I am going to deviate a little 
bit from what we have been talking about.
    Director Thomsen, I think last year the SEC repealed the 
Uptick Rule, and I have had a lot of conversations with a lot 
of folks here recently who tell me, really, with the change of 
that, it almost becomes a self-fulfilling prophecy that now are 
people are shorting on a downtick, and that you keep shorting 
and the ticks. One of the reasons that the Uptick Rule was 
actually put in place back in the 1930's was to bring some 
stability to the markets. Is it time to reconsider the repeal 
of that Uptick Rule in this environment that we are in right 
    Ms. Thomsen. Well, as you know, I do enforcement, but I 
have to say that the Commission has obviously been 
extraordinarily busy considering the substantive area that 
surrounds the Uptick Rule. So for example, the rules that went 
into place this morning at 12:01 that relate to short sales, a 
hard delivery requirement, the exclusion of certain exceptions 
under reg show, an additional anti-fraud rule, all of which 
into effect at 12:01 today, the requirements that are going 
into effect to report short positions on an extremely timely 
basis as well as the enforcement initiatives that are underway 
and will continue to be underway, I think they all demonstrate 
the Commission's acute focus on the subject matter of how to 
address abusive trading.
    Mr. Neugebauer. So back to my original question: Do you 
think it is appropriate at this time to review that rule?
    Ms. Thomsen. I think the Commission is reviewing all rules 
and reviewing all options to address market conditions.
    Mr. Neugebauer. As we are requiring a number of these firms 
to re-purchase a number of these auction rate securities, are 
we in any way possibly jeopardizing the liquidity of some of 
those firms by putting this enforcement action on them and 
maybe creating some other problems?
    Ms. Thomsen. As I mentioned, it was something that we took 
into account as we thought about the remedy and how to get to 
the remedy. I mean first and foremost, I think we were all 
focused on restoring liquidity to investors who had done 
nothing wrong and found themselves without liquidity. But the 
cost of restoring liquidity is, as you suggest, quite high.
    So we worked among ourselves, we talked to--certainly at 
the SEC we talked to our experts in the division of trading and 
markets to understand what were the firms' positions and what 
they could undertake and on the timetable they could undertake 
it. We talked to the firms themselves who reached these 
agreements. Everything we are talking about is something that 
firms agreed to and they are very sophisticated firms so we 
expected them to be worrying about their capacity as well. We 
also, through our division of trading and markets, reached out 
to other Federal regulators, the Fed and Treasury, to 
understand the positions of the firms.
    Baked into these resolutions you will see things like 
timetables, and I think at a certain level, all things being 
equal, you want liquidity restored yesterday and the day before 
and the day before that. But I think the fact that there are 
timetables built into the settlements reflects the fact that 
people were taking into account the capacity, if you will, of 
the firms.
    So I think we have worked very hard to get to a resolution 
that is good for investors but also takes into account the 
    Mr. Neugebauer. Are there auction rate securities that have 
begun to trade again in auctions that have been successful?
    Ms. Thomsen. Yes.
    Mr. Neugebauer. Is there a particular sector where that has 
been more prevalent, or is it a--
    Ms. Thomsen. Well, I know the one that is hardest hit is 
student loans, and the others are coming back. And others, some 
of the issues are being restructured so that, essentially, they 
are being redeemed and restructured in different kind of 
    Mr. Neugebauer. I yield back. Thank you.
    Ms. Waters. Thank you very much. Mr. Watt.
    Mr. Watt. I thank the chairman and the chair pro tem for 
the recognition. I am going to get to a point which I think Mr. 
Galvin was about to get to when he almost ran out of time, at 
least I hope that is where he was about to get to.
    The thing that surprised me as the chair of the Oversight 
Subcommittee of this committee more than anything else is two 
reactions following this whole big market thing, including this 
part of the meltdown. One is everybody is looking for somebody 
to blame, and there is a strong desire for retribution. I want 
to punish somebody, why haven't we put somebody in jail? And 
that reflects itself with me as chair of the Subcommittee on 
Oversight because people keep asking me to have hearings about 
what created this problem and who is at fault.
    I have quite honestly and publicly been very vocal that I 
have no intention of having that kind of hearing unless the 
chair, of course, asks me to have that kind of hearing, because 
I think we need to be focused more on getting the heck out of 
this crisis right now than who was to blame for it or 
punishment. We don't punish in the Legislative Branch anyway. 
Some prosecutor needs to go out there and investigate and 
indict somebody, and there are a bunch of people out there who 
I think are qualified for that, but that is not my job.
    And even the suggestions about reform, really, that I have 
seen, haven't been suggestions about reform. They have been 
about restructuring the regulatory system, who is in charge 
rather than what the person--I mean we had regulators 
regulating all of this stuff, and if they had been competing to 
do their job rather than competing to protect their particular 
constituencies in their industries, we probably would have 
avoided a lot of this stuff. So this whole restructuring thing 
about, ``Let's name a new regulator,'' seems to me to beg the 
question, ``What is the regulator going to do?'' And even all 
of this discussion this morning, except when Mr. Galvin was 
about to get to it and ran out of time, hadn't gotten to that 
question. We have talked about who was at fault, who did what 
bad, we need to restructure, we need to realign the regulation.
    And the single question that I keep asking, and I would 
like each one of you four just to tell me one thing that you 
would do in terms of a specific regulation that would stop this 
from happening in the future, because we have to do something. 
We are already here. Sure we have to dig ourselves out of the 
ditch, but I am looking for something that will stop future 
crises of this kind from happening.
    I have given my speech. Now just one thing. Don't tell me 
realign the regulation because that doesn't tell me what that 
new regulator is going to do. Tell me, whomever the regulator 
is, what they ought to be doing to prevent this from happening 
again. In your little area of the world, here, please, just 
give me one suggestions.
    Ms. Thomsen. I think we ought to do more of what we did in 
this particular cases, which is to work together and bring 
swift law enforcement action to those who have engaged in 
    Mr. Watt. Unresponsive, I'm sorry. Go ahead, Ms. Merrill.
    Ms. Merrill. I wouldn't write a new rule. I think we have a 
lot of regulations that cover what we saw here, and that is why 
we have been able to bring the investigations and the cases 
that we have brought. What you are asking is how can we keep 
from having to bring an action, how can we keep there from 
being this kind of thing again. And there I think we have been 
looking internally, in that when we go out into firms and do--
    Mr. Watt. Ma'am, don't tell me what you have been doing, 
tell me one thing that you would do to stop this from happening 
in the future, please.
    Ms. Merrill. I would question firms at our on-site 
examinations about how they are actually marketing cash 
equivalents, over the phone to their customers, and not just 
look at the script, but question people about what they are 
saying, are they disclosing the risk?
    Mr. Watt. Mr. Galvin. I am sorry.
    Mr. Galvin. Thank you. If I were to summarize in one idea, 
it would be to revisit the idea of whether the significant or 
substantial repeal of Glass-Steagel in the late 1990's was a 
good idea. I think by taking down the wall that existed between 
investing and banking, you open the door for many conflicts, 
and I think if we are going to be serious about regulation you 
have to have rules that make some sense, and I think this one 
didn't, and it is time to change it again.
    Mr. Watt. Ms. Coakley.
    Ms. Coakley. Two things, and they are included in Secretary 
Galvin's testimony. I think you have to prohibit some conflicts 
of interest now, and I think you have to require disclosure on 
others. And the second piece is I think you have to look at the 
financial incentive piece. You have to prohibit some of them 
and you have to disclose others. That has been at the root of 
the subprime mortgage problem, and it is at the root of this.
    They all come from the same lack of appropriate disclosure 
by those who are involved in this. And I say this as an 
enforcer, I'm not a regulatory body, Secretary Galvin is. But 
we can do the autopsy in what happened in the subprime 
mortgage, we can do the autopsy in what happened here, and I 
think Secretary Galvin very succinctly says we need to change 
those rules, how people play this game, because otherwise we 
are going to be back here in 5 years or 10 years with all of 
these enforcement actions.
    Mr. Watt. I yield back. Thank you.
    Ms. Waters. Thank you very much. Mrs. Capito for 5 minutes.
    Mrs. Capito. Thank you, Madam Chairwoman.
    First of all, before I begin, I would like to ask unanimous 
consent to enter into the record prepared statements submitted 
by the Municipal Securities Rulemaking Board and the Regional 
Bond Dealers Association.
    Ms. Waters. Without objection, it is so ordered.
    Mrs. Capito. Thank you. I would like to bring the questions 
down more on a street level, I guess. Could you quantify, just 
approximately, how many holders of these kind of securities 
would have been entities and how many would have been 
    Mr. Galvin. If I may, I think it varied by firm. Some firms 
tended to sell a higher percentage of theirs to institutions, 
nonprofits, for instance. Other firms had a higher percentage 
that were amongst individuals.
    That is why, when we worked out these settlements, we 
focused on different categories such as so-called ``retail 
investors.'' Those were individuals, and small businesses, 
which, again, it varied from case to case, but we set a dollar 
amount, usually about $10 million I think was the number we 
were working with, and then the larger so-called institutional 
investors which were in most of the settlements the last 
category. The theory was that the smaller people, the 
individuals, were probably less sophisticated and also, 
presumably, more in need of the money, whereas the theory was, 
fair or unfair, that the institutions were in a better position 
long term. There is a best efforts requirement on most of these 
    Ms. Merrill. I have some statistics that we were able to 
gather through our survey of over 200 firms; 43 percent of 
auction rate securities were held in retail customer accounts, 
another 21 percent were held by customers who were considered 
high net worth individuals, and 37 percent were held by 
institutional accounts.
    Mrs. Capito. Okay, great.
    Ms. Thomsen. And to add something else, we believe that 
while there were more retail customers in terms of numbers of 
customers, that the holdings were about 50-50 between retail 
customers and institutional customers.
    Mrs. Capito. Okay, another question I have is, for the 
individual who is holding a bond, can you make a distinction--
if somebody is watching this today and they are holding 
something in their account that they thought was a very solid 
State instrument or something that was--how can you make a 
distinction for them between what they are hearing today and 
what they are holding now?
    Ms. Thomsen. Well, I think you raise a very good point and 
something that we ought to mention is that by and large, the 
underlying securities on all of these auction rate securities 
remain solid. That is, the expectation is that the bond will 
pay off according to its terms. What has really been lost is 
the liquidity, which was what it was marketed to be.
    Mrs. Capito. So you couldn't turn around and--
    Ms. Thomsen. Exactly. People thought that they could 
immediately turn this investment--
    Mrs. Capito. Even if it had a 30 year--
    Ms. Thomsen. Even if it was a 30-year maturity.
    Mrs. Capito. Okay. Let me switch gears a little bit here 
then. So the institutions or the folks who have been issuing 
these universities--I mean I represent a small area--government 
entities. How is there liquidity now and they are going out in 
the market and trying to build a new wing to the hospital, 
create a new ambulance authority, or whatever transportation or 
infrastructure. Where is that now? That really troubles me 
because we want to move forward, obviously, for a lot of 
different reasons, but there are a lot of jobs involved in a 
lot of this issuance as well.
    Ms. Thomsen. Well I think this, as a fundraising vehicle, 
capital raising vehicle, is not as attractive as it once was. 
Even at the time people were using auction rate securities to 
raise capital, there were alternatives in underwriting, for 
example, that were more expensive. But I think across the 
board, not just municipalities, but for just about anybody 
trying to raise capital, it is a difficult and more expensive 
environment than it was.
    Mrs. Capito. So it is tight.
    Ms. Thomsen. It is tight.
    Mrs. Capito. I noticed, too, in our briefing papers that 
the issuers of these auction rate securities were allowed, 
permitted in February, to begin buying their own paper, 
essentially. Is that still going on, and what is the situation 
in terms of--it seems to me that could be almost a double hit 
in some ways.
    Ms. Thomsen. Well it was allowed and--okay, I have the 
numbers here. The public sector borrowers have now refinanced 
or made plans to refinance at least $103.7 billion of the 
original outstanding $166 billion in municipal auction rate 
debt, of 62 percent, according to data that was compiled by 
Bloomberg. So that answers your prior question.
    The rule that was put in place in March is still in effect, 
as I understand it, and I think I am going to have to get back 
to you on the impact of that.
    Mrs. Capito. Okay. Thank you.
    Ms. Waters. Thank you very much. Mr. Scott, we are going to 
take you, one from Mr. Royce, and then we are going to go vote, 
and then we will return.
    Mr. Scott. Okay, thank you very much.
    Let me start off by asking, put a quantity around this. 
There is $300 billion worth of investor funds that are still 
locked up, is that right?
    Ms. Merrill. No, they are not still locked up today. That 
number has shrunk dramatically over the last few months thanks 
to the efforts of the regulators and also thanks to some 
restructuring on the part of the issuers. I think we are down 
into the 100 billions now, which is still quite a lot.
    Mr. Scott. And many of these are small investors?
    Ms. Merrill. That is right.
    Mr. Scott. As we got into this, basically the auction rate 
security market, as it was set up, basically catered to your 
smaller individual investor, and as the crisis kind of got 
worse and kind of drifted in and the big banks came to be more 
relied upon as participants. As many of these smaller investors 
are now unable to sell these liquid securities, they haven't 
even looked elsewhere for satisfaction, but there really aren't 
many places that they can go for help, is that correct?
    Ms. Merrill. I think the market actually started out as a 
more institutional market, and over time the issuers allowed a 
smaller amount to be the minimum that you could invest in an 
auction rate security, and once that amount got down to about 
$25,000, that is when you started to see more retail investors 
buying the product and the broker/dealer firms marketing to 
more retail investors. Those investors do, of course, have 
other options of where to put their money. This was marketed by 
many firms as a cash equivalent, which we think was not a fair 
and balanced way to market it, particularly firms that didn't 
highlight the liquidity risk if the auctions failed.
    Mr. Scott. So many of them, their course of action would 
be, as some of the broker firms, some of the larger investors, 
were to file lawsuits, and these lawsuits have been settled 
with them. I am interested to know, given the smaller investor, 
how many lawsuits have been filed by small investors in this 
    Ms. Merrill. We have about 300 claims that have been filed 
in the FINRA arbitration forum by investors. Some of those, 
undoubtedly, will be dropped because some of those investors 
will be part of the buybacks that have been announced today and 
previous buybacks have been announced by other regulators. But 
certainly there are small institutional investors whose firms 
have not yet offered the buyback. We have the FINRA arbitration 
forum available for them and we have set up special procedures 
to make sure that those claims are being looked at fairly and 
    Mr. Scott. And it is fair to assume that many of the 
financial institutions, brokerage firms who represent these 
smaller investors, one could say played a role in this. Are 
they playing a role in helping these small investors, and what 
are the regulators doing to help the small investors? My 
information tells me that the lawsuit option has not been that 
good for small investors because to file a lawsuit costs a lot 
of money in many cases, so that is not an alternative. And my 
picture of this is some of them are just left swinging in the 
wind here, so what are we doing? Are the brokerage houses, many 
of them who might have inadvertently helped get the small 
investor in the mess as it is, are they working, are they doing 
some things? And then what the regulators doing to help these 
small investors?
    Ms. Merrill. What we have been doing at FINRA, really from 
the beginning, is focusing on getting money back to retail 
investors. Our enforcement investigations, I believe, have 
provided the incentive for firms to step up to the plate and 
offer buybacks to their customers. We have five of those cases 
today; $1.8 billion worth of auction rate securities will be 
bought back. Other regulators, the people on the panel with me 
today, have other settlements that have freed up over $40 
billion, I believe, in auction rate securities. So we are 
focusing on getting those funds back.
    I agree with you that the best solution is to have the 
firms do the buybacks as quickly as possible, but we do have 
the arbitration forum there for customers whose firms have not 
yet entered into those settlements.
    Mr. Scott. Thank you very much.
    Ms. Thomsen. I think it is fair to say that the settlements 
to date, and including the ones that FINRA just announced, if 
you focus on retail investors, the smaller investor, a large 
majority of those investors will have the opportunity to get 
cash back, 100 cents on the dollar, all of their interest paid 
to date as well as an opportunity to recover any consequential 
damages through a FINRA process that is quite streamlined 
without ever having to file a lawsuit.
    Mr. Scott. That is good to hear. Thank you.
    Ms. Waters. Thank you very much. We have 5 minutes to get 
to the Floor. Mr. Royce has a burning question that he wants to 
    Mr. Royce. Just one. Director Thomsen, the settlements have 
not specified how individuals' funds held in fiduciary accounts 
and invested short term in student loan auction rate securities 
and now due back to the individual investor, or for closing an 
individual transaction, how that is to be handled. And the 
investment banks who sold the student loan auction rate 
securities for short term investment are unsure if they are to 
redeem these smaller individual investments held in fiduciary 
accounts on the front end of their settlements. For example, 
should they be treated the same as any individual holding the 
security directly? That is my short question.
    Ms. Thomsen. And our objective is to get the small retail 
investor redeemed early and first, and we are working out those 
details as we finalize these settlements.
    Mr. Royce. In terms of this fiduciary account situation, 
that would be an affirmative or--
    Ms. Thomsen. It will be something that we are going to 
address as we finalize it.
    Mr. Royce. Thank you. Thank you, Madam Chairwoman.
    Ms. Waters. Thank you very much. Panel, you have been very 
patient and very good. However, we do have other members who 
have questions that they would like to ask.
    We have to go to the Floor; we have two votes. One is a 15-
minute vote, and the other is a 5-minute vote. If we go and 
take these votes, and take about 5 minutes to get back, we 
should be back in 25 minutes, so I would like to ask you to 
please remain so that our other members will have an 
opportunity to ask their questions. Thank you very much.
    Ms. Waters. The committee will come to order. I would like 
to ask our panel, Ms. Thomsen, Ms. Merrill, Mr. Galvin, the 
Honorable Secretary of the Commonwealth of Massachusetts, and 
the Honorable Martha Coakley, Attorney General, to please 
return, and we will start with Mr. Green of Texas for 5 
    Mr. Green. Thank you, Madam Chairwoman. I thank the 
witnesses, the members of the panel. I thank the chair of the 
full committee. Let's start with acquiring a better 
understanding of what the auction rate security is. We are 
talking about a long-term bond that has short-term interest 
rates that are reset about every 28 days, and they are reset as 
a result of an auction process.
    Now when we say that it fails, that we had a failure of an 
auction rate security, what does that mean, in essence? What 
happened in the technical sense, in the procedural sense, what 
happened? Some folks showed up to bid, or what happened?
    Ms. Thomsen. There aren't enough buyers.
    Mr. Green. And when you have a dearth of buyers, how does 
that impact the sale itself, the actual--
    Ms. Thomsen. The holders continue to hold the security. 
There's no sale. So you continue to hold the security, and if--
in a failed auction, the interest rate typically goes up, the 
interest rate paid to the holders is--gets higher and it goes 
high enough in theory that the expectation is that there will 
be an incentive at the next auction for there to be buyers, or 
for the issuer to restructure because it's an expense--
    Mr. Green. Would you define ``holder'' for me, please?
    Ms. Thomsen. The people who bought the securities in the 
past auction and who hold them.
    Mr. Green. So the person who purchased initially in this 
process in a past auction when they had a failure, and you 
didn't have enough buyers, that person had a smile, and said, 
wow, my interest rate just went up?
    Ms. Thomsen. If what they are looking for is interest rate, 
that's right.
    Mr. Green. Okay.
    Ms. Thomsen. The interest rate went up.
    Mr. Green. Okay.
    Ms. Thomsen. If they are looking for liquidity, they will 
have a frown.
    Mr. Green. But if the interest rate is important, then that 
was a good thing for this person?
    Ms. Thomsen. Absolutely.
    Mr. Green. The interest rate just went up. Does it go up 
    Ms. Thomsen. It goes up--depending on the type of security, 
whether it's corporate or whether it's a student loan.
    Mr. Green. That's a good point. Let's talk about the type. 
Individuals can purchase auction rate securities, correct?
    Ms. Thomsen. Yes.
    Mr. Green. And you have classes of individuals. You have 
the average Joe, a person like me who might have $25,000 that 
he scraped up and he buys, and then you have a wealthier class 
of individuals as well, two classes?
    Ms. Thomsen. Yes.
    Mr. Green. And these individuals who are holding long-term 
bond, short-term interest rate, interest rate goes up, 
initially, the impact is not adverse to their best interest if 
they are not interested in immediate liquidity?
    Ms. Thomsen. If they are not interested in liquidity, they 
have earned a higher interest rate. That's correct.
    Mr. Green. So it's the liquidity that creates the problem 
in terms of persons coming in and saying, hey, I need my money 
    Ms. Thomsen. Exactly.
    Mr. Green. --and I would like to have the interest rate 
that you promised me as well. That works pretty fine, it works 
well as long as everybody doesn't show up at the same time 
usually. Is this one of those cases where if some show up and 
say I need my money it's okay, but if you have a great number 
that show up, you have a problem?
    Ms. Thomsen. No. It is an auction, so the people who want 
to sell arrive through their broker-dealer at a certain date, 
and there have to be enough purchasers so that they can all be 
liquidated at the same time.
    Mr. Green. Okay. Now moving forward to the process, 
continuing with this, we have in this process a group of people 
who are known as broker-dealers?
    Ms. Thomsen. Yes.
    Mr. Green. Okay. And the broker-dealers, they work with the 
    Ms. Thomsen. Some of the broker-dealers just sell the 
investments. They are the sort of secondary ones that Ms. 
Merrill was talking about. Some are also underwriters and 
participated in structuring the products in the first place.
    Mr. Green. Do the broker-dealers come into contact with the 
average Joe who had the $25,000?
    Ms. Thomsen. Yes.
    Mr. Green. Okay. These are the people who, in a sense, 
engage in some sort of marketing process, whether it's 
secondary. There may be a primary marketer that gets me in. 
They are secondary tertiary, or maybe even quadirary in the 
process, but they are in the process?
    Ms. Thomsen. Yes.
    Mr. Green. And these broker-dealers are allowed to see the 
investors bid before the bid is submitted?
    Ms. Thomsen. Yes. I think that's right. Yes.
    Mr. Green. They see the bid?
    Ms. Thomsen. Yes.
    Ms. Merrill. Yes.
    Mr. Green. Now if they see the bid before it is submitted, 
can that--not saying that it does in every case--but can that 
have an adverse impact on the process?
    Ms. Thomsen. That was the subject matter of the action we 
brought in 2006, that this auction practice itself, and as a 
result of that action, those who run auctions and who settled 
in 2006 were required to disclose their auction practices.
    Mr. Green. Do this because my time is up. Do this for me. 
Tell me what is the adverse impact of the broker-dealer 
actually knowing what the bid is before it is submitted. Tell 
me that, please.
    Ms. Thomsen. There's a possibility that there could be 
favorable treatment and negotiating towards a price to the 
middle, if you will.
    Mr. Green. Okay. Explain that, please. This is an important 
aspect of it. What actually happens here? Because we are 
getting to the heart of this. It's about deception, if not 
fraud. Explain it to us, please.
    Ms. Thomsen. In the auction rate process, the broker-dealer 
who sort of, if you will, underwrote the security, had two 
interests that were of interest to that broker-dealer. One of 
the issuer. The issuer's interest is to raise capital at the 
lowest price possible. The other is the purchaser of the 
security, who of course wants the highest interest rate 
possible, and not to overgeneralize, but in the case involved 
in 2006, we found conduct by broker-dealers that was 
undisclosed to the issuers or the purchasers that was trying to 
get the price, if you will, into the middle, trying to prevent 
failed auctions as well as holder auctions where no one was 
willing to sell, and to get an interest rate that was, if you 
will, in the middle.
    Mr. Green. Thank you.
    The Chairman. Thank you. The gentleman from Colorado is now 
    Mr. Perlmutter. Thank you, Mr. Chairman, and my friend Mr. 
Green. He and I are always on the same wavelength, and he's 
asking a lot of the questions that I would like to ask, because 
there's a microeconomic kind of a transaction piece to this. 
There's a macroeconomic piece to this, which is what is the 
whole world doing with these things, and then there is either 
the marketing piece, which can be either fraudulent or accurate 
or whatever.
    So I just have to say--there are sort of four truisms that 
I have to mention before I ask my questions. If it's too good 
to be true, it generally is. If something has to come to an 
end, it will. Res ipsa loquitur, the thing speaks for itself. 
And the last one right up there, e pluribus unum. And I want to 
start with that piece, because--and I want to focus this on my 
chairman and also the ranking member.
    The problems that we have in the financial market today are 
gigantic. This is one sliver of it. And when we have good 
times, we can be many and do all sorts of things on our own, 
and we'll be fine. When we have tough times--and we are in 
tough times--we are in the vortex of some kind of financial 
hurricane that none of us understands. We come together, and 
it's going to take a lot of challenges and a lot of work and a 
lot of sacrifice on the part of everybody here is going to have 
to pick up the pieces, and millions of people across this 
    And this committee, because of the--I think the bipartisan 
nature and the way that our ranking member and our chairman 
work together, we are going to be able to help America get back 
on track.
    So the res ipsa loquitur, for the lawyers on the panel and 
for everybody out there, the thing speaks for itself. This 
apparently turned out to just be a mess. Because on one day we 
have people investing in these kinds of instruments, and the 
next day $330 billion or whatever Mr. Galvin said, is gone. 
And--you know, these auctions go from 2 percent to 22 percent 
to try to make these things move. So let's go to the 
microeconomic piece. My mom comes in, you know, his average 
Joe. My mother comes in. She wants to buy $10,000 of these 
things. She sees--she's told, okay, you're going to buy a long-
term bond and you're going to get interest rate X and you ought 
to be able to get out of this in 30 days, or did they say you 
will get out of this in 30 days? What was the promise that was 
made by the middle man?
    Ms. Thomsen. It depends person to person, obviously, but by 
and large, I think our evidence suggests that these were 
marketed as you can get out of it any time you want. It's as 
good as cash. And it provides a slightly better interest rate.
    Mr. Perlmutter. But there--I would say there is some 
responsibility on my mother's part to say, wait a second. I'm 
buying a long-term bond. I'm getting this little higher 
interest rate, and I'm promised this liquidity. At the end of 
the day, I'm still buying a long-term bond, right?
    Ms. Merrill. Don't be so sure that is what they were told. 
I am not sure that--
    Ms. Thomsen. Some didn't even know they were in an auction.
    Ms. Merrill. Yes. I'm not sure that investors were told 
this is a long-term bond with a reset at a short-term interest 
rate. I'm not sure they were told anything like that. I think 
they were in many cases told, here's a cash equivalent, like--
maybe like a money market. You'll be able to get your cash out 
every 7 days or every 28 days, whatever the auction period was. 
So, I'm not sure they actually were told this is a long-term 
bond with a short-term interest rate.
    Mr. Perlmutter. So then it was a fraud from the outset?
    Ms. Thomsen. It depends person to person and sales practice 
to sales practice. We have seen instances where people did 
understand that it was a bond, that it was set at auction, but 
they understood that they were getting a higher interest rate, 
a slightly higher interest rate than say a money market fund, 
because they were giving up liquidity for 7 days.
    Mr. Perlmutter. All right. So now let's go to the 
macroeconomic piece of this. Who was buying this stuff? Was my 
mother buying this or was China buying this, or who was buying 
this? And why did they stop buying it? Because they saw the 
potential for deception or something else? And I know you're 
all on the enforcement side of this thing, but who was buying 
it and why did they stop?
    Ms. Thomsen. The investors were both retail and 
institutions. There were more retail investors in terms of 
numbers than institutional investors, but the amount was split 
about 50-50 between them. While it's always difficult to tell 
the reasons things seize up, beginning in 2007, as the credit--
the subprime credit crisis hit, there was softness in this 
market. That was not necessarily transparent to the investors.
    But one of the things that happened--the other thing that 
happened is that this market grew relatively dramatically. In 
2006, the amount outstanding was over $200 billion. By 2008, 
when it froze, it was over $300 billion. That is a lot to 
absorb. And then in January of 2008, the monoline insurers that 
sort of back these securities were downgraded, and that 
affected to a certain extent we believe, people's perception of 
the creditworthiness of the security. And so it was not very 
long after--
    Mr. Perlmutter. So would that be the AIG or some other 
organization thing? We are going to--
    Ms. Merrill. Ambac, BIA, yes.
    Mr. Perlmutter. Not only is this a good investment, but we 
are going to insure it's a great investment.
    Ms. Merrill. Yes.
    Mr. Perlmutter. So then the insurer goes down, people start 
getting nervous. Now were there any big blocks of purchasers? I 
mean, I want to know if there was a lot of foreign investment 
that stopped and really started this house of cards tumbling. 
So we have a fragile economy, a fragile market, but it was just 
generally everybody stopped?
    Ms. Thomsen. I don't believe so. What happened was that 
increasingly beginning in the summer of 2007, the underwriters 
were coming into the auctions to keep them from failing. So 
they would put in bids so there were no failures, which meant 
that they were taking on more of these securities onto their 
books as they were becoming less liquid in a time when they 
were having a hard time carrying illiquid securities. And I 
think they hoped at some level that the market would recover 
and they wouldn't have to keep doing this, and by February, in 
combination with the monolines, the pressure became so great 
that they simply stopped supporting the auctions.
    Mr. Perlmutter. Okay. Thank you.
    The Chairman. The gentleman from California and then the 
gentleman from Missouri.
    Mr. Sherman. Thank you. I would like to digress for a bit 
here, Ms. Thomsen, to talk about not securities that are pretty 
close to complying with SEC laws, or laws administered by the 
SEC, to a different issue. Is the SEC authorized and does it 
have people who are pretending to be investors in dealing with 
all these investments out on the Internet, etc., that are just 
obviously, blatantly in violation of securities law?
    Ms. Thomsen. We do not. We cannot operate undercover. We 
can't pretend to be anything other than--
    Mr. Sherman. And is that a failure of Congress to give you 
that authority, or is that also a failure of the SEC to ask for 
    Ms. Thomsen. I believe it reflects the fact that we are a 
civil law enforcement agency, and that we work with--
    Mr. Sherman. So if we want to focus on legalisms and we 
have always done it that way and we are just civil, then we can 
have a circumstance where no one is protecting the investor who 
is so unsophisticated that they are willing to invest in 
something that is an obvious violation of securities law. The 
reason I bring this up is, it's by no means clear that anybody 
in this room is going to protect really smart people from 
themselves. The one thing we know the government could do is 
protect the ignorant. But you don't want to, or you're not in 
that business, and Justice doesn't want to either and Congress 
doesn't want to do anything about it.
    Ms. Thomsen. Actually--
    Mr. Sherman. And so as much as we can talk here about 
exactly who was an inch over the line, the people who are 10 
miles over the line are pretty safe. I'll let you respond.
    Ms. Thomsen. Well, I hope not. And it's our effort to not 
keep them safe. I was going to say that we have been working--
we work with criminal authorities when they can go undercover. 
And one of the things that I put in my submitted testimony is 
while we have been focusing on auction rate securities and what 
we have been talking about, we have brought three hundred and 
eighty-some other cases during that same time period, and 
included among them are some really frankly outrageous ponzi 
    Mr. Sherman. If you're not pretending to be an investor, if 
you don't want to be in criminal law enforcement, if you 
don't--because I'll tell you right now, my local DA has crime 
on the streets. He doesn't exactly want to focus on crime in 
the suites. And you're here to talk about how we are going to 
protect the smart people, and I wish you were here saying we 
have to have your people pretending to be unsophisticated 
investors in cleaning up the part of this that we can clean up.
    Now shifting to the purpose of--I will introduce 
legislation, but without SEC support, I'm going to have to be 
even more persuasive than my usual level of persuasiveness. I 
probably won't be successful. Now what has happened here is 
that the market is under price risk. They achieve this by 
ignoring risk and telling others to ignore risk. And in 
particular, today's hearings focus on 30-year bonds issued by 
private corporations and they are priced in the market as if 
they are Treasuries or insured deposits.
    Now the issue--one view of this is widows and orphans were 
sold a bill of goods by smart people who knew better. But as 
far as I can tell, all the smart people on Wall Street thought 
these were accurately priced. Was anybody selling these short 
in a big way? Was there anybody smart enough to say the market 
has massively underpriced the risk here?
    Ms. Thomsen. I don't believe you can sell these short.
    Mr. Sherman. What?
    Ms. Thomsen. I don't think you can sell these short.
    Mr. Sherman. Okay. Was anybody investing, say selling short 
the stock of the monoline insurance companies who insured 
these? Was anybody smart enough to realize that these things 
were not priced correctly and there was money to be made 
because the market was dumb?
    Ms. Thomsen. I don't believe we have evidence of that.
    Mr. Sherman. So we are in a situation where, yes, it's true 
individual investors may have been told, hey, it's as good as 
cash, or almost as good as cash, or really what you're saying 
is, it's only 100 basis--it's only 20 basis points worse than a 
Treasury and you're getting 25 basis points in return for that. 
The fact is, the smartest people on Wall Street seemed to have 
believed this utterly false tale.
    Ms. Thomsen. I'm not sure I would go that far because I 
believe those who underwrote beginning in the summer of 2007 
knew what was happening in the markets, knew they had to go in, 
knew that liquidity was failing.
    Mr. Sherman. But they were buying these.
    The Chairman. The time has expired. She can finish the 
answer, but we are over--
    Mr. Sherman. Okay.
    Ms. Thomsen. I think that those who underwrote understood 
that the liquidity feature was being undermined and degrading 
as they continued to sell them.
    The Chairman. The gentleman from Missouri.
    Mr. Cleaver. I like Dan Quayle--let me just make an 
announcement. Dan Quayle's grandfather was a very prominent and 
profound Methodist bishop. There are Quayle United Methodist 
churches all over the States of Kansas and Oklahoma, Quayle 
buildings on college campuses, Methodist college campuses. Dan 
Quayle was not quite so profound, however, as his grandfather. 
In a speech trying to make reference to the motto of the United 
Negro College Fund, which is ``a mind is a terrible thing to 
waste,'' Vice President Quayle got a little mixed up and said, 
``It's a terrible thing for a man to lose his mind.'' And I 
happen to agree with him.
    I would like to misquote him some more. A crisis is a 
terrible thing to waste. I think that we are in a major crisis. 
I don't think anybody who can read or hear would contradict 
that statement, and I think that if we are going to go through 
all of this pain, we need to come out on the other side, having 
made some adjustments and changes, because a crisis is a 
terrible thing to waste. And by that I mean I'm wondering 
whether or not we need maybe a new kind of an enforcement 
structure that will deal with these knotty issues that keep 
cropping up, in addition to some stringent regulations.
    I'm interested in your comments. But, for example, many of 
the ARS contracts actually allowed broker-dealers to see 
investor bids before they were submitted to the auction agent, 
which of course gave the broker-dealers an unfair advantage. 
And if that is legal, wouldn't it suggest that there is a need 
for some serious regulations? And then of course as has been 
discussed widely this morning, some investment banks actually 
sold products as cash equivalents. And if that is legal, we 
need some strong regulations.
    So I actually have one question with a couple of 
components. And the thing is, do you agree that now is the time 
for us to deal with this crisis and come out on the other side 
with regulations? And then secondly, is there a need for a new 
enforcement arm? Not all at once, but--
    Ms. Thomsen. Well, let me start by saying I agree with you 
that a crisis is a terrible thing to waste. You can learn 
lessons from it and decide what if anything you should do 
differently. With respect to a new enforcement model, we are 
here because the enforcement tools we have allowed us to bring 
enforcement actions in this arena. We were able to get this 
liquidity back to investors on really very, very short order 
because the behavior was illegal and because we worked 
together. So I think in terms of enforcement tools, we had some 
pretty good ones and we used them well in this instance.
    That being said, I always want more, but I think it's fair 
to say that in terms of the enforcement tools that were 
available to address this problem, they were adequate to the 
problem, and I think the combined efforts of everyone you see 
here and the hundreds of people who aren't there using them was 
used to good advantage.
    Mr. Cleaver. I appreciate the fact that the attorneys 
general forced a buyback of some of the ARS. I think that was 
good. But then the second part comes, and that is, is there a 
need for some stronger regulatory components for enforcement? I 
mean, I know--before you answer, you know, if you answer the 
phones in our offices whether you're a Republican or a 
Democrat, people are angry all over this country, and I'm not 
sure how many people want to go home and stand up in front of a 
crowd and say, well, you know, we had a couple of little 
problems and they'll work themselves out, you know. The market 
always is self-correcting. I mean, people want to know, number 
one, are the people who violated the law going to have to pay 
for it? And then secondly, is this going to happen again? Have 
you guys done anything to make certain that this doesn't happen 
    Ms. Merrill. If I may respond to that?
    Mr. Cleaver. Ms. Merrill.
    Ms. Merrill. First of all, I completely agree with you that 
the financial crisis that we see all around us today is 
something that we have to review and assess in terms of 
reforming our regulatory system.
    Our CEO, Mary Shapiro, has talked about the fact that the 
regulation of this country, the way we regulate financial 
products, has to be fixed. It is a patchwork. Often it is split 
on product lines, and yet when you talk to a consumer, the 
consumer isn't split on product lines. In other words, they 
need an insurance product. They need securities, they need 
bonds. And they don't want to hear that a different regulator 
is in charge of each one of those different aspects of their 
entire financial health. So we do have to do something to fix 
that sort of alphabet soup of regulation that we have.
    In terms of the enforcement piece, I'll just take another 
adage. I don't know if Dan Quayle has used this one, but an 
ounce of prevention is worth a pound of cure. And I wouldn't 
look for a new enforcement arm. I would go back and look at how 
could we have been smarter about seeing these issues before 
they came to the enforcement front. And that's where we have 
spent time internally looking at what can we do on our 
examination program when we are in firms, when we go in to 
examine our member firms, what should we be looking at to see 
how they are marketing products. Should we be looking at 
products that people have been thinking about as safe for 20 
years, and really digging down into some of those products?
    We spend a lot of time looking at the way firms market very 
risky and very complex products, derivative products, but I 
think what we are seeing in this crisis of the auction rate 
securities is that even something that's marketed as as good as 
cash, something that was perceived to be by the firms to be 
relatively simple, isn't always as simple as it seems.
    Mr. Cleaver. Ms. Coakley, I'm interested--I mean, you have 
taken people to court.
    Ms. Coakley. We actually didn't, because when we went to 
Merrill Lynch and UBS and said you have broken the law under 
Massachusetts, you cannot sell these kind of auction rate 
securities to municipalities, it's illegal, they said, okay, we 
better pay you back, which is what they did. So we didn't have 
to sue.
    My answers to your questions are yes and yes. I have 
forgotten what the questions were but I knew I had the answers 
at the time you asked them.
    Mr. Cleaver. Well, you know, in my time on this committee, 
you are the first person since I have been here who has 
answered the question directly and quickly. I have been waiting 
for you for years.
    Mr. Cleaver. Thank you. Mr. Galvin?
    Mr. Galvin. Thank you. I think you touched upon one issue 
in your question, that's clearly I think the conflict of 
interest issue, when you spoke of the bidders being--the bids 
being revealed, and I think that's something that has to be 
addressed. It has to be, in my opinion, this would be a 
regulatory change, there has to be much stronger and direct 
regulation relating to conflicts of interest, not just in 
auction rate securities but in a broader way.
    Secondly, I think the concept of a fiduciary duty, 
especially in the case of those that would actually be selling 
these, and this gets to the sales practices issue, there has to 
be some duty imposed upon the seller to be aware at least of 
the circumstance of the buyer, and whether that's cast in terms 
of disclosure, which many of us have spoken to, or an 
affirmative obligation to say that if you know that that person 
left your office believing--or is in your office believing this 
is liquid and you know it's not, you have an obligation to 
disclose that to them and you should not sell it to them if you 
know it's not in their best interest. Those are some specifics.
    I think on the enforcement side, you can rearrange the 
structure. I think this instance here demonstrates I think the 
structure has worked collaboratively rather well. I think the 
bigger problem, as has been mentioned by Ms. Merrill, is the 
anticipatory side of enforcement. In other words, when you have 
an enforcement action, you have already had a failure. You have 
had something go wrong. There has to be something done on the 
other side to anticipate problems with products that are out 
there. There has to be a review of products that are out there.
    As I said, I think what has clearly been discredited--you 
spoke of a crisis, and there's no question that there is one. 
What has clearly been discredited in my opinion is this idea 
that the free market is going to figure this all out. Products 
will fail. No one will ever buy them again and it has corrected 
itself. Not without great loss. Not just the individual loss to 
the people who have been away for their money for a long time, 
but to the collective economy of our country.
    This money that has been tied up, whether it's individual 
money, small business money or institutional money, is money 
that could have been working in our economy during this very 
critical time, and it wasn't available. So I think it has to be 
an anticipatory enforcement as well as an enforcement after the 
    Mr. Cleaver. Your answer is yes, too.
    Mr. Galvin. Yes. Yes.
    Mr. Cleaver. Thank you.
    The Chairman. I thank the panel. We will move on to the 
next panel now. I apologize, but--oh, I'm sorry. Ms. Speier. I 
didn't see Ms. Speier. The gentlewoman from California is 
recognized for 5 minutes.
    Ms. Speier. Thank you, Mr. Chairman. I'm going to try and 
focus my questions on three areas: Professional misconduct; 
cost recovery; and the enforcement activities going on in 
States other than Massachusetts. My hat is off to you in 
Massachusetts. You are doing an outstanding job. I worry that 
we are not doing what you're doing in Massachusetts around the 
    But first let me move to professional misconduct. As I look 
at the description of your organization, FINRA, Ms. Merrill, 
it's a little unnerving to me. It's a self-regulatory regime 
based on something we took off your Web site, that your focus 
is on registering and educating and you're dedicated to 
investor protection.
    Now based on what we have heard today, the use of auction 
rate securities was only used by sophisticated institutional 
individuals since 1984. And then 3 years ago, that was changed, 
in which it was opened up to less sophisticated investors who 
had $25,000 or more. Now who made the decision to reduce the 
requirements as to who could get into these auction rate 
securities? And maybe this goes to Ms. Thomsen and to Ms. 
    Ms. Merrill. I'm not sure that the level of $25,000 was 
only lowered 3 years ago.
    Ms. Speier. It said a few years ago in our packet.
    Ms. Merrill. Okay. But it is true that the auction rate 
securities market originated as being sold primarily to 
institutional investors. The $25,000 level is something that is 
set by the issuer, I believe, in terms of what they will allow 
as the minimum amount that can be purchased at the auction.
    Ms. Speier. Okay. If that is the case, the issuer can do 
that on their own. Doesn't it seem appropriate for you to 
then--interested in protecting investor interests, to require 
greater disclosure to those investors that are less 
sophisticated? And why didn't you?
    Ms. Merrill. For every security that is sold by a broker-
dealer to a customer, for every one that is recommended, our 
suitability rules require that broker-dealers make an 
affirmative determination that the product is suitable for that 
individual investor. And they have to take into consideration 
things like the risk tolerance of the individual, their 
investment horizon, and their need for liquidity. And if they 
don't do that, then we bring cases against brokers. We have 
brought over 500 cases against individual brokers who have just 
this year alone, against individual brokers who have 
recommended unsuitable investments to their individual clients.
    Ms. Speier. All right. I have only 5 minutes, so I am going 
to cut you off just ever so briefly.
    Ms. Merrill. I appreciate that.
    Ms. Speier. Have you filed--do you have authority to file 
any action against individual brokers--
    Ms. Merrill. Absolutely.
    Ms. Speier. --to take their licenses away from them?
    Ms. Merrill. Absolutely.
    Ms. Speier. Have you done that in this particular scenario 
with the auction rate securities?
    Ms. Merrill. In the auction rate security area, we started 
with the companies, with the broker-dealers themselves because 
they are the ones who can supply the solution that we really 
wanted, which is to buy back investors' money. But we have not 
stopped, and we are continuing our investigation as to 
individual brokers, and where we find that there have been 
misrepresentations and suitability violations, we do have the 
tools and we have used them again and again to bar people from 
the securities industry--
    Ms. Speier. For how long?
    Ms. Merrill. Permanently.
    Ms. Speier. Permanently?
    Ms. Merrill. Permanent bars.
    Ms. Speier. And how often have you used that?
    Ms. Merrill. We have over 300 permanent bars this year 
alone, and another two hundred and some suspensions on top of 
    Ms. Speier. But none in the auction rate securities area?
    Ms. Merrill. But our investigations are not complete.
    Ms. Speier. All right. Let me move on to cost recovery. How 
much did it cost you to do your investigation, Ms. Thomsen?
    Ms. Thomsen. I don't know the answer to that, but other 
than the cost to our budget, if you will, deploying our 
resources, this did not cost the government anything.
    Ms. Speier. Well, but it did.
    Ms. Thomsen. Obviously. Wherever we investigate, we are not 
investigating somewhere else.
    Ms. Speier. Do you have the authority to seek cost recovery 
from the entity that you find has done wrongdoing?
    Ms. Thomsen. No. We do have the authority, and we use it, 
to get penalties which go back either to the government or in 
fair funds to investors. We did not--we have not yet sought 
penalties in these matters because we wanted to make sure that 
all available resources were being used to recompense 
investors, and because we deferred the issue of penalty until 
the end of the process to make sure that the firms had actually 
stayed true to their word and had made investors whole.
    Ms. Speier. I think for the American public, they are less 
concerned about making sure that the money just gets back to 
the institutions. I mean, they certainly want the money to come 
back to them as individuals. But they also want people 
disciplined. And they certainly don't want the taxpayers of 
this country to pick up the tab to have to do the investigation 
of folks who weren't complying with the law to begin with, and 
that's why I believe you should have the authority for cost 
recovery and why I would seek to have our committee look at 
that issue.
    The Chairman. If the gentlewoman wants an additional 2 
minutes, go ahead.
    Ms. Speier. All right. Thank you. And to you, Attorney 
General Coakley, I'm impressed by what you did in 
Massachusetts, and to you, Secretary of State Galvin. I worry 
that unless States have taken on this that there are many 
institutions and individuals who are not going to be made 
whole. I'm curious as to whether or not the U.S. attorneys 
around the country have engaged, and if not, why not, and would 
like your thought on whether or not there should be some 
nationwide class action brought.
    Ms. Coakley. Well, in a nutshell, you know, the SEC as a 
Federal agency has regulatory authority over institutions, and 
in many instances, States are preempted from banks and 
regulatory authority there for a long time. We have approached 
it from the point of view of what our own State's statutory 
authority lets us do. We have a False Claims Act. We have 
Chapter 93(a) that does consumer protection, and we have a 
statute in Massachusetts that says you can't sell to cities and 
towns products like this that aren't liquid. So that's the 
basis on which we were able to go forward in this instance.
    But I think your question actually redounds to what the 
chairman's comments were at the beginning, that when we look at 
the overall picture here in terms of the auction rate 
securities and predatory lending and all of these pieces, I 
think Secretary Galvin and I would be strong voices, along with 
the chairman, to say we need a strong Federal regulatory 
    We need strong enforcement, including whatever else you 
think in terms of cost recovery, but you need to allow States, 
depending upon how much of this activity takes place in the 
State, what is in the interest of that legislature, that 
enforcement, to be able to work in a very complementary way to 
look at from the ground up what is happening. And I think in 
this instance the States--it's not only Massachusetts; New York 
has done a lot, and California has done a lot. That's where a 
lot of this activity takes place and where these financial 
houses live. But that whole piece of how we are going to do 
this has to I think be approached with the State piece of it, 
not preemption for us and let the States do what they feel they 
need to do.
    Mr. Galvin. Just to put your mind at ease, the North 
American Securities Administrators Association has taken this 
on and has worked with the Securities and Exchange Commission. 
And while State entities have brought individual actions, they 
have been representing the national interests. So in other 
words, it's open to every State. And indeed, even in the fining 
structure, that is the penalty structure, some States that were 
not lead States will still get some fine as a result of this.
    So, for instance, when Massachusetts negotiated with regard 
to Bank of America, we negotiated for all Bank of America 
customers throughout the United States, and the agreement we 
secured from Bank of America was applicable to all customers. 
Similarly with Fidelity, which was a downstream broker, in 
which we just entered an agreement with last week. That's for 
all of Fidelity's customers. It's not limited to Massachusetts 
    So there has been a comprehensive effort here on the part 
of the States, but I think the concern is that, you know, what 
about the next time? This was a remarkable case of 
collaboration and a very effective case of collaboration, but I 
think the anticipatory issues are the really--the bigger issues 
that you folks are going to have to deal with.
    The Chairman. I thank the panel, and this has been very 
useful. We will take the next panel now.
    I thank the panel. I apologize for the delay in getting to 
you. There is a lot of interest in this subject. We will begin 
with Ms. Leslie Norwood, the managing director and associate 
general counsel of the Securities Industry and Financial 
Markets Association, SIFMA. Ms. Norwood.


    Ms. Norwood. Good morning, Chairman Frank, and members of 
the committee. My name is Leslie Norwood, and I am managing 
director and associate general counsel of the Securities 
Industry and Financial Markets Association. I serve as the 
staff advisor to the Association's Municipal Securities 
Division. Thank you very much for the opportunity to testify on 
the auction rate securities market today.
    The credit crisis over the last 18 months is like none we 
have ever experienced before. As problems in the mortgage 
market spread into mortgage securitization in 2007, faith in 
the monoline insurers, insurers of mortgage bonds and 
collateralized debt obligations, began to waiver. Investors 
became wary of being exposed to anything with a potential for 
downgrades, including any securities connected with the 
insurers themselves. Because of the critical role the insurers 
play in the ARS market, demand for ARS and other variable rate 
securities began to show signs of decline, and the number of 
failed auctions increased.
    While this is not the first time ARS auctions have failed, 
this is the first time a significant number of auctions have 
failed. Between 1984 and 2006, only 13 out of thousands of 
municipal securities auctions failed. By contrast, 31 failed 
municipal securities auctions are estimated to have occurred 
during the second half of 2007 alone. As the demand for ARS 
began to evaporate in 2007, many broker-dealers purchased ARS 
in order to support the market and to prevent failed auctions. 
Pursuant to the terms of the legal offering documents, broker-
dealers were not and are not obligated to support an auction. 
As the credit crisis began to impact the liquidity and capital 
of the broker-dealer firms, many firms lacked the capacity to 
continue supporting the ARS market.
    The issues in the ARS market are unprecedented and flow 
from overall issues in the financial markets. While SIFMA 
cannot speak to the specifics of the sales and marketing 
practices of various firms, it is fair to say there were 
deficiencies in the market. I'm sure you will hear many 
anecdotes about sales and marketing practices. It is important 
to remember that the liquidity problems in the ARS market are a 
result of the ongoing credit crunch. While there were 
disclosures made to customers about the risks associated with 
ARS, in hindsight, the disclosures could have and should have 
been better. As the committee is aware, several firms have 
settled or are in the process of negotiating settlements to buy 
back ARS to provide liquidity to investors.
    While it is of little comfort to investors expecting 
liquidity, for the most part, ARS issuers are still to this day 
paying interest and principal payments on securities to 
investors as they come due and the underlying credit ratings of 
ARS issuers remains high. The ARS failures have left issuers to 
face steep increases in the cost of capital. Some State and 
local government issuers of securities have found their 
securities resetting to maximum rates as high as 20 percent. 
The high maximum rates compensated the investors for their loss 
of liquidity and encouraged issuers to restructure these 
securities into a more cost-effective form of debt.
    As stated earlier, in 2006, the SEC settled with 15 broker-
dealer firms for auction practices that were not adequately 
disclosed to investors. In light of the settlement, SIFMA 
developed best practices for broker-dealers of auction rate 
securities, which describes the role of the broker-dealer in an 
auction. SIFMA also created the SIFMA auction rate securities 
indices to serve as a benchmark for issuers and investors.
    SIFMA and its member firms have sought action to ease the 
regulatory burdens which hampered efforts of the municipal 
issuers to redeem or restructure their outstanding ARS. SIFMA 
and its member firms are helping issuers to restructure their 
ARS. In addition, over the last few months, a number of firms 
have agreed to buy back securities at par value from customers. 
However, many firms are facing capital limitations as a result 
of the continuing credit crunch, limiting the funding available 
to buy back outstanding ARS. I would like also to note that not 
all firms have the same level of activity in the ARS market. 
Some firms underwrote securities, some firms acted as selling 
agents, and other firms merely had these securities transferred 
to them from other firms due to customer account transfers.
    Many firms also faced regulatory constraints. For instance, 
if a broker-dealer holds inventory of a particular ARS issuer, 
its affiliate bank is limited in how much credit assistance it 
can offer a distressed issuer because of Regulation W, which 
limits the size of covered transactions. A safe harbor for 
Regulation W for these firms would allow banks to buy back more 
of their outstanding ARS.
    SIFMA and the broker-dealer community are also actively 
working with the MSRB, the Municipal Securities Rulemaking 
Board, on its new disclosure system for ARS and VRDOs, which 
will expand their new disclosure system called EMMA, the 
municipal securities version of the SEC's EDGAR System.
    In conclusion, auction rate securities were an attractive 
source of funding for State and local governments and student 
loan financing authorities for over 2 decades. A tightening of 
the credit markets led to a sharp decline in the demand for ARS 
and ultimately resulted in failures across the ARS market. The 
broker-dealer community is working to return liquidity to the 
ARS market and to assist issuers in refinancing and 
restructuring their ARS as quickly as possible.
    Thank you for the opportunity to testify before you today, 
and I look forward to answering your questions.
    [The prepared statement of Ms. Norwood can be found on page 
107 of the appendix.]
    The Chairman. I am now going to go a little bit out of 
order, and I would ask unanimous consent that we allow our 
colleague from New Hampshire, Ms. Shea-Porter, to sit with us. 
I hear no serious objection, therefore, she is allowed to 
participate. I should note that because of the situation 
involving New Hampshire and education, Ms. Shea-Porter has been 
one of the Members most active and energetic in calling on us 
to do what we can to facilitate this, and I would now call on 
her to make a statement and introduce the next witness.
    Ms. Shea-Porter. Thank you very much, Mr. Chairman, and 
thank you for the privilege of joining you for this important 
hearing. I am pleased to have the opportunity to industry a 
fellow New Hampshirite, Ms. Tara Payne. Ms. Payne is here to 
share with the committee the New Hampshire Higher Education 
Assistance Foundation, or as we call them, NHHEAF, experience 
with the auction rate securities.
    The NHHEAF network is made up of four nonprofit 
organizations that collectively serve as New Hampshire's 
leading provider of college planning and funding. She has 
worked for the NHHEAF network since 1996 and currently serves 
as the vice president of corporate communications and 
marketing. Thank you so much for being here today, Ms. Payne. I 
look forward to hearing your testimony.
    And thank you again, Mr. Chairman, for the opportunity to 
participate. I yield back.
    The Chairman. I thank the gentlewoman. I should point out 
that we have had a great deal of cooperation here between this 
committee and the Committee on Education and Labor, which has a 
specific interest in education. And one of the things I'm proud 
of in this Congress is that we really avoided, I think, the 
kind of jurisdictional hair pulls that just annoy everybody and 
shouldn't happen. And with regard to the impact of auction rate 
securities on education funding, we have been able to be 
cooperative. I appreciate the Education and Labor Committee, 
having worked with them. They have had some constructive 
results, the chairman tells me, in dealing with the Federal 
Department of Education. So we are glad you're with us. Ms. 
Payne, why don't you go ahead, and then we'll get back to the 


    Ms. Payne. Thank you. Chairman Frank, Ranking Member 
Bachus, and members of the committee, I am Tara Payne, 
representing the New Hampshire Higher Education Loan 
Corporation. It is an honor to participate in these 
discussions. I would like to thank the representative from New 
Hampshire who continues to be a strong advocate for student 
access to higher education. Thank you.
    Thousands of schools and millions of students have relied 
upon FELP providers to finance postsecondary costs. In our 
capacity as a nonprofit student loan provider, NELCO takes 
great pride in educating students about responsible borrowing. 
Consequently, we consistently have among the lowest cohort 
default rates in the Nation. When students successfully repay 
their Federal loans, everyone benefits. Taxpayers don't have to 
shoulder the burden of increased Federal debt to cover loan 
losses. Schools maintain their eligibility to award Federal 
financial aid, and best of all, students realize the full 
benefit of the investment they have made in higher education.
    The FELP community is dedicated to promoting college 
access, particularly for underserved students, and it does so 
by offering an extensive array of college outreach programs. 
The impact of these programs is enormous and widespread. 
Consider that in New Hampshire alone, 95 percent of public high 
schools and 34,000 students and parents relied on the services 
we provided last year, and I must stress the importance of 
having agencies such as ours across the Nation.
    One of the unintended consequences of the legislative cuts 
to subsidies for nonprofit lenders and the current liquidity 
crisis is the risk of losing programs like the Center for 
College Planning in New Hampshire. Access to college begins 
with increasing aspirations, but it ultimately ends with the 
availability of financial aid programs and funding options.
    We are proud of the integrity and commitment we have made 
to these programs, but in this year, fulfilling our most 
essential mission has been extremely challenging. NELCO is New 
Hampshire's leading provider of student loan financing and 
funded $184 million in Federal loans and $67 million in 
alternative loans in Fiscal Year 2007. In all, NELCO has $1.5 
billion in outstanding bonds which have funded our program 
since 1997.
    The auction rate market has been an important key source 
for liquidity for student loan lenders. For the last decade, 
NELCO borrowed money to fund loans by selling auction rate 
certificates. However, investors are no longer investing in the 
auction rate market, thus issuers like NELCO can't raise 
capital that funds loans.
    Our organization has always held itself to a high standard 
of financial accountability. We recognize that we bear 
responsibility to ensure that whatever taxpayer money is spent, 
our program is minimal and that access to higher education is 
made possible through our sustaining a strong financial base. 
This strong base has been significantly compromised by NELCO's 
long-standing trusted financial advisor, the UBS Securities 
    On August 14th, the New Hampshire Bureau of Securities 
Regulation announced that it was taking action against UBS for 
fraud. The action relates to UBS's representation of NELCO in 
the sale of bonds. Essentially, the order issued by the Bureau 
states that UBS knew that the market for these bonds was on the 
verge of collapse. At the same time that UBS was actively 
encouraging NELCO to extend its commitment on these bonds, UBS 
advised NELCO to reset the maximum rate on NELCO's taxable bond 
to 17 to 18 percent to ensure liquidity and prevent auctions 
from failing.
    We now know this was a scheme. It was a scheme to make the 
securities more attractive to investors and to keep NELCO in 
the market. UBS never disclosed to NELCO that the market was at 
risk of freezing and that the maximum interest rate payable on 
the bonds could lead to NELCO's financial harm, or that UBS was 
preparing to end its support of the market as it had always 
    On February 13, 2008, UBS stopped supporting the market and 
it collapsed, leaving NELCO and investors with billions of 
dollars frozen. We support the New Hampshire Bureau in its 
assertion that UBS failed in its fiduciary and moral duty to 
    Alternative loans have become a key factor in affordability 
and access. NELCO's non-Federal alternative loan program 
provided funding to close the gap between what students receive 
in financial aid and what the college actually costs. In Fiscal 
Year 2007, over 6,000 students borrowed $67 million through our 
alternative loan program. Still, recognizing the severity of 
the liquidity crisis, the reduction to lenders from recent 
legislation, and the lack of viable solutions from our 
financial advisor, NELCO was forced to suspend its alternative 
loan program in March, leaving thousands of students to search 
for other alternatives.
    Any interruption in the loan program hurts college-bound 
students. It causes a disruption in financial aid delivery and 
creates another layer of complexity to a tedious financial aid 
process. Naturally, this has the greatest impact on our most 
vulnerable students. Following our suspension of the 
alternative loan program and becoming gravely concerned about 
our ability to fund even Federal loans, NELCO asked the member 
institutions of the New Hampshire Bankers Association and New 
Hampshire credit unions to provide liquidity that would enable 
NELCO to fund the Federal program. Currently, $94 million has 
been raised, and I can assure you that NELCO would have 
suspended its Federal program if it were not for the 
overwhelming support of community lenders to provide a 
temporary solution prior to the Ensuring Continued Access to 
Students Loan Act.
    Thank you sincerely for your time.
    [The prepared statement of Ms. Payne can be found on page 
123 of the appendix.]
    The Chairman. Thank you.
    Next, Mr. Roger Sherr, the vice president of Sherr 
Development Corporation.


    Mr. Sherr. Thank you, Mr. Chairman. My name is Roger Sherr, 
and I am vice president of Sherr Development Corporation, a 
Michigan-based real estate company that has been creating 
retail and construction-related jobs since the mid-1980's. I 
appreciate the opportunity to address this committee.
    My purpose is to describe how Comerica Bank's 
misrepresentation regarding auction rate preferred securities 
purchased on our behalf has harmed our company, individuals who 
would have worked for our company if not for the 
misrepresentation, our community, and the overall integrity in 
the financial system.
    In 2005, our company sold a number of retail shopping 
centers. At that point, we had an unusually large cash 
position. Our intent was to park those proceeds for a 
relatively short period of time, intending to pay capital gains 
taxes, and then redeploy those monies in other projects as 
opportunities presented. Our goals for the funds were safety 
and liquidity. We made those goals clear to Comerica Bank, 
which has served as our family's and company's bank for over 60 
    Comerica directed the purchase of specific auction rate 
securities as a place to park those funds. Comerica sold these 
securities as cash equivalents. There was no disclosure of any 
risk to liquidity or value. The particular securities we now 
loan are listed for you in my written testimony.
    In February of this year, we were stunned to learn that as 
a result of the freezing of the market for ARPS, our funds 
placed by Comerica were no longer available to support our 
ongoing business operations. In multiple letters to Comerica 
officials, we requested the bank to follow through and give us 
our promised cash on demand. Even though Comerica selected the 
specific securities we purchased and earned healthy 
commissions, they refused to shoulder any of the responsibility 
for their misrepresentation.
    Until recently, Comerica has repeatedly refused to 
repurchase these securities or participate in any settlements 
with regulators. We now understand that as of this morning, 
Comerica has agreed to cooperate with regulators and repurchase 
the securities that it sold to retail investors. We only hope 
that this would have come more voluntarily from Comerica 
without regulators and enforcement officers breathing down 
their back at a significant cost to taxpayers.
    Having cash on hand provides important competitive 
advantages for a firm our size. It allows us to move quickly 
and pursue projects we may not otherwise have been able to do. 
To the extent retail opportunities we pursue create jobs in 
America, the liquidity of our balance sheet is important. It 
may be of interest that in the past, Sherr Development has 
completed retail and residential-related projects with 
aggregate values exceeding $250 million. As a result, thousands 
of jobs have been created, and millions in taxes have been 
    The Michigan economy is facing some difficult times today. 
Comerica's failure to fully correct the illiquid condition at 
our company has directly contributed to tough times in 
Michigan. One investment, for example, we would have pursued is 
the development of a large shopping center in the City of 
Detroit. It would have provided needed retail services for 
people living in the area, as well as hundreds of highly paid 
construction jobs and hundreds of retail positions. Because our 
funds are still locked up with these auction securities, we 
were not able to make a rapid decision and pursue this project. 
As of now, the site remains undeveloped, and residents in the 
area need to travel further distances for the groceries and 
other goods they need. Others in the area may remain unemployed 
or underemployed.
    Comerica Bank has $60 billion in assets, and ranks as one 
of the top 20 banks in the country. It advertises that it puts 
its customers first, and has hundreds of branches to serve you. 
Unlike Goldman Sachs, Merrill Lynch, or UBS, Comerica is a 
hometown regional bank, trusted to sell safe products designed 
to protect their customers. Comerica's customers have a good 
reason to hold them to a higher fiduciary standard of care than 
is applicable to brokers in the fast-paced world of investment 
    Comerica sold more than 2 billion of these securities to 
individuals, municipalities, and firms like ours that pay taxes 
and create jobs. Clearly, given the resources and 
sophistication of the bank, they should have understood and 
accurately communicated the types of securities they were 
selling in large volumes. If they had advised us and other 
customers of the true nature of these securities, they would 
have not have been purchased as money market instruments. Like 
any retailer, they should be held responsible for their 
    It is important to note that judicial remedies alone are 
not sufficient here. If we and thousands of other firms, 
municipalities and individuals are forced to go to court for 
justice and wait months, if not years, to be heard, the economy 
will suffer in the short and the long term. In the short term, 
without access to funds, firms like ours cannot create 
desperately needed jobs. In the long term, trust and confidence 
in the banking regulatory system, which is now facing a 
critical challenge, will be further eroded.
    In conclusion, many firms such as ours relied on their 
local bank for sound, conservative money management advice. In 
this case, Comerica sold auction rate securities as cash 
equivalents and misrepresented the products they sold. As a 
result, our business has been damaged, we have been unable to 
create needed jobs, and the trust in the banking system has 
been undermined.
    Thank you.
    [The prepared statement of Mr. Sherr can be found on page 
134 of the appendix.]
    The Chairman. Next, we will hear from Mr. William Adams IV, 
vice president of Nuveen Investments.


    Mr. Adams. Chairman Frank, and members of the Financial 
Services Committee, thank you for inviting me to testify about 
the continuing turmoil in the auction rate securities market 
and about possible solutions.
    We commend you for holding hearings on this important topic 
and appreciate the opportunity to express our views. My name is 
Bill Adams, and I am executive vice president of Nuveen 
Investments. Nuveen sponsored closed-end funds together 
represent the largest issuer of auction rate preferred 
securities and we share the committee's deep concern over this 
issue and its impact on investors.
    One hundred of our closed-end funds had more than $15 
billion of auction rate preferred shares or what I'll call ARPS 
at the time this market failed in February. Since the failures 
began, my team has worked very hard to resolve the problem for 
our funds shareholders. The failed auctions have prevented tens 
of thousands of Nuveen shareholders from selling their ARPS and 
have increased fund financing costs for the fund's more than 
one million common shareholders.
    As you and your constituents well know, this problem has 
created significant, financial hardship for many preferred 
shareholders. Following the breakdown of the ARPS market, 
Nuveen and the funds' independent directors determined that it 
was the absence of market liquidity rather than credit concerns 
regarding our funds that caused the auction failures. We also 
concluded that the existing ARPS market was unlikely to return 
to normal.
    In March, Nuveen and the funds announced that they would 
seek to refinance all the funds' outstanding ARPS. Our goal was 
to reduce the funds' cost of borrowing for the benefit of 
common shareholders, while providing liquidity at par for the 
funds' preferred shareholders. Since then, we have kept all our 
shareholders fully informed of our progress and the challenges 
we face. The unprecedented turmoil and the financial markets 
has made it even more challenging. Still, we have made 
significant progress.
    To date, Nuveen's closed-end funds have redeemed or have 
announced their intention to redeem nearly $5 billion of their 
$15 billion of outstanding ARPS. So how have we refinanced the 
ARS? Our first approach has been to employ conventional 
financing methods to the greatest extent possible. This 
includes bank loans, lines of credit, and other forms of 
secured lending as well as tender option bonds. Most 
importantly, we have created a new form of preferred stock 
called, ``variable rate demand preferred,'' or VRDP. This new 
security offers two critical benefits.
    One, like the ARPS, it allows our municipal closed-end 
funds to obtain financing at favorable tax-exempt rates, and 
two, because of the liquidity backstop from a bank, VRDP is 
eligible for purchase by tax exempt money market funds, the 
largest buyers of short-term, tax exempt securities. In fact, 
we recently sold $500 million of this new preferred stock to 
refinance all the ARPS for four of our funds and we believe 
there is a lot more demand for money market funds that could 
allow the Nuveen funds and potentially all closed-end funds to 
refinance all ARPS to cash out ARPS shareholders.
    We appreciate the guidance we have received from the SEC 
and the Department of the Treasury, and the sense of urgency 
this committee has imparted on regulators and market 
participants to find creative solutions. We have made progress, 
but clearly there is more to be done. We have learned through 
our discussions with banks and institutional investors that a 
number of regulations continue to limit our funds' ability to 
issue larger amounts of VRDP and resolve this issue more 
    I would like to end by highlighting three suggestions. The 
first would be for the Federal Reserve to broaden the ability 
of banks to own VRDP in their role as liquidity providers and 
to permit banks to pledge VRDP as collateral at the Fed 
discount window. This would remove the obstacles that have 
limited the ability of banks to provide liquidity backstops for 
VRDP. Second, the SEC should expedite its consideration of 
relief under the Investment Company Act to temporarily permit 
closed-end funds to use debt financing to a greater extent than 
currently permitted. And, third, it would help if the Treasury 
Department would further clarify the equity treatment of 
preferred securities that include liquidity backstops and to 
permit not only fixed-income funds but also equity funds to 
issue such preferred securities.
    Again, thank you for the opportunity to explore these 
issues and potential issues on behalf of the millions of 
investors caught up in this unprecedented situation. I look 
forward to answering your questions.
    [The prepared statement of Mr. Adams can be found on page 
60 of the appendix.]
    The Chairman. Thank you, and finally, I am going to step in 
for my colleague, the second ranking member of the committee, 
and the chairman of the Capital Markets Subcommittee, Mr. 
Kanjorski, who wrenched his back today. He is unlike most of 
the people concerned with the financial services interview 
today in that he has a pain in his back.
    The Chairman. I am therefore glad to introduce a man with 
whom he has worked and who appeared with us at the press 
conference earlier on when we announced this hearing. And I 
have to say that as important as this hearing is, I think our 
having announced it a couple of months ago was probably the 
biggest contribution we made to getting things moving.
    James Preston is president and chief executive officer of 
the Pennsylvania Higher Education Assistance Agency. I know Mr. 
Kanjorski welcomes the assistance and advice he has given us.
    So, please, Mr. Preston.


    Mr. Preston. Thank you very much. I am Jim Preston, 
president and CEO of Pennsylvania Higher Education Assistance 
Agency (PHEAA). I would like to thank Chairman Frank and 
Ranking Member Bachus for holding this hearing. I am especially 
grateful to Mr. Kanjorski for his leadership on the student 
loan aspect of this important issue and his support of a 
comprehensive solution to the student loan liquidity issue.
    As someone with more than 25 years of investment banking 
and student loan funding experience, I can attest that today's 
situation is unprecedented and is in urgent need of attention. 
The fact is nobody knows how long it will be before today's 
problems become too deeply rooted to be resolved without 
extensive government intervention. The collapse of the auction 
rate securities market and the dysfunction of other markets 
which might have provided alternative sources of funding for 
not-for-profit student loan secondary markets have left 
nonprofit agencies with few, if any, ways to raise needed 
funds, funds that students and families depend upon to meet 
college costs.
    In May, Congress took a first step by passing the Ensuring 
Continued Access to Student Loans Act, ECASLA, which has been 
crucial in assuring access to Federal student loans for this 
fall. And last night, an Act passed again to extend it for one 
more year. However, this Act is little more than a temporary 
solution and applies only to federally-guaranteed student 
    Unless Congress and the Administration address the 
underlying cause of the current liquidity difficulties, there 
will be continued instability in the student loan marketplace. 
In March of this year, PHEAA reached the conclusion that we 
must suspend origination and purchasing of Federal student 
loans. The cost of raising capital to fund student loan 
originations and purchases had become financially impossible. 
There was no way to generate a positive return on our 
investment, and additionally traditional sources of liquidity 
were withdrawn and just not available.
    We simply could not sustain limitless, unlimited losses, 
and continue to provide access to student loans and maintain 
essential services to the citizens of Pennsylvania. To finance 
the loans we have made and purchased over the years, PHEAA 
maintains nearly $12 billion in outstanding debt obligations. 
These obligations take many forms and involve a mix of both 
taxable and tax exempt; approximately $7.4 billion is in the 
form of auction rate securities.
    PHEAA uses these funds to originate student loans and to 
serve as a secondary market for student loans. By purchasing 
loans from originators for par plus a reasonable premium, based 
on the value of the loans, PHEAA enables hundreds of lenders to 
participate in the Federal student loan program. These lenders, 
which rely on secondary markets to recycle their funds in order 
to make new loans, now find themselves with no outlet for the 
loans they originate. Their balance sheets are filling up 
rapidly, which cannot be continued indefinitely.
    Today we find ourselves unable to issue new debt 
obligations due to the lack of investors, and because even if 
investors are found, the price required is too high to allow 
issuers to make or purchase loans without losing money on each 
new loan. Additionally, rating agencies and credit providers 
are demanding that debt issuers add substantial capital of 
their own to any new security, which is a significant obstacle 
for those of us without access to funds.
    We realize that any effort to provide vehicles to fund 
student loans must benefit three groups: The investors who find 
their assets trapped in these investments; the issuers who are 
unable to refinance these securities; and the Federal 
Government, which should not bear any financial burden as a 
result. Earlier this year, PHEAA in concert with two sister 
agencies put forward a proposal to Treasury that we believe 
would accomplish all three of these objectives.
    Since then, Treasury has adopted the core principles of 
this proposal, but has done so not for student loans but for 
mortgaged back securities as part of its rescue of Fannie Mae 
and Freddie Mac. Treasury's plan is to create a new market for 
mortgage-backed securities; in essence, to stand in place of 
the global markets, which are unable to supply sufficient 
capital to support the homeowners of this Nation.
    Our proposal is for Treasury to do the exact same thing for 
student loans. In Treasury's fact sheet that accompanied their 
announcement on September 7, 2008, Treasury stated clearly that 
taxpayers will benefit from this program, directly through 
potential returns on the Treasury's portfolio of mortgage-
backed securities. We believe these same principles would apply 
to a program to purchase student loan backed securities. And 
since FFELP loans are already 97 percent guaranteed by the 
Federal Government, such a plan would be 97 percent less risky 
for the Federal Government than actions that involve non-
guaranteed assets.
    Overall, guaranteed student loans are reliable, performing 
assets, and they are not subprime loans. Earlier this year, 
Treasury advised Congress that it requires new statutory 
authority to purchase student loan-backed securities. Thus, we 
urge you Mr. Chairman and members of the Financial Services 
Committee to provide Treasury with such authority. You can do 
so by adopting H.R. 5914 sponsored by Representative Kanjorski.
    Please give us the chance to solve this issue before too 
many players are forced to end their participation in the 
student loan program to the detriment of millions of Americans.
    Thank you for allowing me to appear here today.
    [The prepared statement of Mr. Preston can be found on page 
129 of the appendix.]
    The Chairman. Thank you, Mr. Preston.
    I heard what you said, and I really appreciate your 
participation. This has been mutual.
    We have some votes. They are going to take an hour, so we 
are not going to ask you to stay.
    I am going to ask Ms. Shea-Porter if she has any questions. 
Again, I think the willingness of the people here to 
participate in this hearing has moved this ball forward. We 
will be looking at your testimony and will try and do it 
tomorrow. But Ms. Shea-Porter will have time for questions.
    Ms. Shea-Porter. Thank you, Mr. Chairman.
    Ms. Payne, I did want to ask you, the collapse of the 
market clearly had a significant impact on NHEF. It was around 
this time that the auctions failed that NHEF announced it was 
suspending its alternative loan programs. How many students 
were impacted by the suspension, and what has happened to them?
    Ms. Payne. Well, at this point, there have been over 6,000 
students who last year participated who this year could not and 
had to find other alternatives. Right now, we are actually 
doing a survey to find out where those borrowers have landed. 
However, we know from past surveys that 28 percent of students, 
even prior to the crisis, were putting tuition on credit cards. 
I can only imagine that number has increased, particularly now 
that parents aren't able to get, say, second mortgages.
    It has become more difficult for those private loan 
providers out there. It has become more difficult still for 
students to access money, because of tightening credit 
restrictions. So we are not sure exactly, and I think that we 
may see a big shift second semester as well. Students were able 
to use summer earnings to manage through a first semester. 
We'll be interested to see what happens by second semester as 
    Ms. Shea-Porter. So do you suspect that not only are they 
taking the dead-on on credit cards but that maybe some of them 
aren't even trying to go anymore, that they have given up on 
the idea?
    Ms. Payne. Again, only through stories that we have had 
through families who have come into our office overwhelmed by 
this. You know, we know the kids definitely were able to get 
some funds through other lenders, national lenders perhaps, but 
at what price? I mean, certainly, for a much higher price than 
they were through a nonprofit agency and that will flush itself 
out, I think, by mid-year.
    Ms. Shea-Porter. Okay. Thank you.
    I yield back. Thank you.
    The Chairman. And finally, on behalf of our absent 
colleague, I believe the gentlewoman from New York, Mrs. 
Maloney, has some questions.
    Mrs. Maloney. Just very quickly, Mr. Preston. Earlier this 
year, Congress passed the Ensuring Access to Student Loan Act 
to ensure liquidity in the student loan market; and, while this 
has been beneficial to many lenders, other smaller, nonprofit 
lenders still have much of their now illiquid auction rate 
securities. What is being done to help these smaller nonprofit 
lenders, and what more can be done for them to ensure that they 
can continue to lend to our students?
    Mr. Preston. The small nonprofit lenders play an important 
part in the overall delivery system in the United States, not 
only for origination directly to students but also buying from 
banks that participate. And it's very important to keep the 
banks in this business to support the higher education program.
    What we are finding, just like many of the small, secondary 
markets in the United States and the not-for-profits is that 
there are no financing alternatives available. For example, 
when the auction rate started to deteriorate, many of us, all 
of us, probably, went and started lining up bond insurance and 
letters of credit to refinance.
    I was in New York on January 18th, when MBIA and Ambac got 
downgraded. That day was a threshold event, because then all 
the options started going away and, by February, the auctions 
then started failing. So whether it's a big or small not-for-
profit, we are all in the same boat and it's all affecting the 
whole chain of delivery of student loans through the banks.
    Mrs. Maloney. On that point, can anyone on the panel speak 
on the point that he raised on why the auction rate security 
market froze back in February?
    And then going forward, what reforms do you believe the 
auction rate security market needs to be made viable again so 
that we can continue these student loans and other activities? 
Why did it freeze in February?
    Mr. Preston. I will take a shot at it. I think it froze 
because it became apparent there weren't other alternatives 
available to refinance and that it just became a point of 
diminishing returns for those holders. And, you know I think 
the auction rate market is not a viable product now or in the 
future. If it does come back, it will have to come back as a 
specific, institutional product where the risks are clearly 
understood and they are willing to hold it. But I just don't 
see that product as being viable.
    So solutions going forward will have to be the variable 
rate demand market coming back, which is insurance and 
liquidity from the banks, and the floating rate note market 
which is the overseas market. Those are our only options to 
finance variable rate products, both tax exempt or taxable. And 
until those stabilize, we don't have any options to refinance.
    The Chairman. I thank the panel. If there are any further 
comments you want to submit later, we will take them. I think 
this has been useful.
    Oh, I'm sorry. The gentleman from Colorado.
    Mr. Perlmutter. I just want to thank the panel and I also 
want to say that our Congressional Research Service often gets 
overlooked. They have put a heck of a report together that we 
got as of today, the kind that goes through the chronology of 
this and is very instructional. So I think for everybody on the 
panel as well as the members of our committee, and you guys 
often go overlooked. You do a great job in helping us 
understand these things.
    Thank you, Mr. Chairman.
    The Chairman. I appreciate that, and I think we have gotten 
some resolution on the current situation, although not to 
everybody's satisfaction. They weren't entirely satisfied.
    As for the future, while this specific instrument is 
probably not going to occur, everybody, I think, learned some 
lessons about what we should put in place if anything similar 
shows up.
    I thank the panel, and the hearing is adjourned.
    [Whereupon, at 1:45 p.m., the hearing was adjourned.]

                            A P P E N D I X

                           September 18, 2008