Oh no… Why is it a surprise to hear that Wall Street has been selling to CMO securities to retail investors in these times of sharply reduced liquidity? And now Wall Street's regulators need to investigate?

As this Wall Street Journal article suggests, "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." Apparently, The Financial Industry Regulatory Authority ("FINRA"), 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. These letters, part of an on-going "sweep" operation directed at more than a dozen Wall Street firms, asks for PowerPoint presentations, sales scripts and detailed customer-account information from June 30, 2006, through July 31, 2007.

The WSJ article discloses that FNRA "specifically asks for offering documents on products sold, created or distributed during the months of March and June 2007." Toomre Capital Markets LLC ("TCM") notes with interest that those months just happen to coincide with the quarter ends for three of the largest Wall Street entities with both large retail brokerage personnel and the biggest CDO losses from aggressive underwriting – UBS, Merrill Lynch and Citigroup. Could these firms and others possibly have tried to cram as much CMO (and CDO) product down less sophisticated retail channels ahead of their earnings reports? No, Wall Street never would do such a thing…

It is telling that the FINRA letters also are asking for any customer complaints or litigation arising from the sale of the CMO/CDO products. They are also asking for the names of the brokers that generated the highest commissions at the firms from selling these products. Finally, FINRA also requests that the firms 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. TCM would suggest that FINRA also request electronic lists of all retail transactions and especially focus on those transactions that deviate by more than say one half point from where the firms marked those securities at the end of that specific trade date.

It also would be very interesting to see how the firm's internal valuations of holdings differ from the prices that are displayed on retail customer statements at the end of the month. Certainly the value of a position with millions of dollar of face amount is quite different from one that is just a few thousand or even hundreds of thousands in amount. One would hope and expect though that the retail valuation would be equal to or less than the institutional valuation because God forbid what would happen if a retail investor tried to sell a CDO or CMO security in the secondary market these days.

The sale of fixed-income securities and particularly mortgage securities are fraught with potential abuse when dealing with retail investors. FINRA and the Securities and Exchange Commission are doing well 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.