Wells Fargo (WFC) will pay $6.5 million to the Securities and Exchange Commission to settle claims it improperly sold commercial paper to investors backed by risky mortgage bonds and collateralized debt obligations.
The bank's brokerage shop allegedly recommended municipalities and nonprofits buy short-term asset-backed commercial paper from structured investment vehicles, known as SIVs — as well as the hyper-mortgage focused SIV-lites.
SIV-lites issued short term paper for liquidity provisions, backed by longer-term mortgage-backed securities and collateralized debt obligations, which were tied to risky subprime mortgages. The collapse of the SIV market happened quickly as market liquidity began to dry up, and the SIVs struggled to fund their operations.
In this case, the SIVs sold the commercial paper through the Wells Fargo brokerage house to fund its purchases of MBS and CDOs tied to subprime home loans, according to the SEC. Many of these SIVs overleveraged themselves — the long-term collateral failed to pay the short-term obligations — and by 2007, three of the SIV-issued ABCP programs defaulted. The bank's clients who bought the paper took substantial losses. A total of 10 Wells clients held $104 million in the commercial paper when the defaults begain, according to the SEC.
Three of the most highly leveraged SIV programs were rated AAA by three major credit ratings agencies. One of them known as Rhinebridge defaulted after being on the market for only four months – around the time it was set to receive its first payment from the mortgage bonds and CDOs it invested in, according to the SEC.
In 2007, as the housing market began to implode, credit ratings agencies began downgrading SIVs. The ABCP market has since fallen to a $300 billion market from a height of $1.2 trillion five years ago, according to Credit Suisse (CS) research.
The government claimed representatives in Wells Fargo's brokerage division did not review certain documents and risk disclosures before selling the instruments. The bank's brokerage service and its former vice president Shawn McMurtry relied too heavily on credit ratings instead, investigators said.
"Accordingly, the registered representatives had little information about these securities beyond their ratings, yields and maturity dates. In fact, multiple registered representatives at Wells Fargo had never heard of a SIV at the time they were selling the SIV-issued asset-backed commercial paper to their customers," according to the SEC charges. "In each case, the very scenario that took place in the market in 2007 had been described with precision in the risk disclosures in the (private placement memoranda)."
Wells Fargo admitted no guilt in the settlement.
"These issues occurred more than five years ago and pertain to a part of the firm that was completely revamped after the merger with Wachovia. We are pleased to put this matter behind us," a bank spokeswoman said.
"Broker-dealers must do their homework before recommending complex investments to their customers," said Elaine Greenberg, chief of the SEC Enforcement Division's municipal securities and public pensions unit. "Municipalities and other non-profit institutions were harmed because Wells Fargo abdicated its fundamental responsibility as a broker to have a reasonable basis for its investment recommendations to customers."
Jacob Gaffney contributed to this report.