Watchdog Probes Wall Street's
Role in the Mortgage Industry

Securities regulators, broadening their review of Wall Street's role in the mortgage industry, have asked several brokerage firms for information about the marketing and sale of mortgage-related products, specifically those sold to individual investors.

The Financial Industry Regulatory Authority, Wall Street's self-regulatory body, last month sent letters to firms asking for documents, including marketing materials, a list of supervisory policies and procedures, and descriptions of how collateralized mortgage obligations were valued, according to a copy of the letter reviewed by The Wall Street Journal.

The letters were sent to more than a dozen brokerage firms believed to be involved in the CMO market, one person familiar with the matter said. It is unclear which brokerage firms received the letter.

The letters, dated Dec. 14, were sent from Finra's enforcement division in what has been described as a "sweep" investigation, which is a broad look at industrywide practices that doesn't necessarily result in an enforcement action. The letter asks for PowerPoint presentations, sales scripts and detailed customer-account information from June 30, 2006, through July 31, 2007. Firms have until Tuesday to respond.

The Finra letter suggests that the regulators are looking into whether brokers sold these risky investments to individuals just as the market for related products was collapsing. Finra specifically asks for offering documents on products sold, created or distributed during the months of March and June 2007. The mortgage market had weakened since the previous fall and fell sharply over the spring and summer.

The sweep comes amid probes by the Securities and Exchange Commission and several state attorneys general into how Wall Street firms are valuing mortgage-related products and how they packaged and sold them to investors. A spokesman for the SEC said the commission's examination division plans to conduct its own sweep examination in coordination with Finra.

Collateralized mortgage obligations are pools of residential home mortgages. Investors can receive income from the cash that flows from the underlying mortgage payments. They can be risky investments, however, if the homeowner falls behind or can't pay the mortgages. The value of CMOs has suffered amid the increasing number of defaults in high-risk home mortgages.

Regulators are probably looking to see whether firms sold the products to investors without disclosing the risks, or to investors who didn't have the financial wherewithal to take on riskier investments. In September, Finra Chairman Mary Schapiro said the agency was conducting a sweep to see whether some firms were targeting senior citizens with CMO products. The letter sent to the brokerage firms is the second leg of that sweep.

"Finra's interest in CMOs is consistent with its continued regulatory scrutiny of what it perceives as abusive sale practices directed at seniors or retirees," notes a memo from the law firm of Sutherland Asbill & Brennan LLP.

Regulators are asking for any customer complaints or litigation arising from the sale of these products. They are also asking for the names of the brokers that generated the highest commissions at the firms from selling these products.

Finra is also asking firms to provide descriptions of how they priced the CMOs daily and at the end of the month, as well as the policies governing whether investors were able to borrow money to purchase the products.

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