The Securities and Exchange Commission recently charged Wells Fargo’s brokerage firm and a former vice president for selling investments tied to mortgage-backed securities without fully understanding their complexity or disclosing the risks to investors.
The SEC found that Wells Fargo improperly sold asset-backed commercial paper (ABCP) structured with high-risk mortgage-backed securities and collateralized debt obligations (CDOs) to municipalities, non-profit institutions, and other customers. Wells Fargo did not obtain sufficient information about these investment vehicles and relied almost exclusively upon their credit ratings. The firm’s representatives failed to understand the true nature, risks, and volatility behind these products before recommending them to investors with generally conservative investment objectives.
Wells Fargo agreed to pay more than $6.5 million to settle the SEC’s charges. The money will be placed into a Fair Fund for the benefit of harmed investors.
“Broker-dealers must do their homework before recommending complex investments to their customers,” said Elaine C. 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.”
According to the SEC’s order instituting settled administrative proceedings against Minneapolis-based Wells Fargo Brokerage Services (now Wells Fargo Securities), the improper sales occurred from January 2007 to August 2007. Registered representatives in Wells Fargo’s Institutional Brokerage and Sales Division made recommendations to institutional customers to purchase ABCP issued by limited purpose companies called structured investment vehicles (SIVs) and SIV-Lites backed largely by mortgage-backed securities and CDOs. Wells Fargo and its registered representatives did not review the private placement memoranda (PPMs) for the investments and the extensive risk disclosures in those documents. Instead, they relied almost exclusively on the credit ratings of these products despite various warnings against such over-reliance in the PPM and elsewhere. Wells Fargo also failed to establish any procedures to ensure that its personnel adequately reviewed and understood the nature and risks of these commercial paper programs.
The SEC’s order finds that Wells Fargo and its registered representatives failed to have a reasonable basis for their recommendations. They also failed to disclose to their customers the risks associated with the complex SIV-issued ABCP investments, including the nature and volatility of the underlying assets. A number of customers purchased SIV-issued ABCP as a result of Wells Fargo’s recommendations, and many of them ultimately suffered substantial losses after three SIV-issued ABCP programs defaulted in 2007.
The SEC charged former vice president Shawn McMurtry for his improper sale of SIV issued ABCP. McMurtry exercised discretionary authority in violation of Wells Fargo’s internal policy and selected the particular issuer of ABCP for one longstanding municipal customer. McMurtry did not obtain sufficient information about the investment and relied almost entirely upon its credit rating.
Wells Fargo and McMurtry were, at a minimum, negligent in recommending the relevant ABCP programs without obtaining adequate information about them to form a reasonable basis for recommending these products and without disclosing the material risks of these products. As a result, they violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.
The SEC’s order finds that Wells Fargo has taken a number of remedial measures since 2007 to ensure that its registered representatives have adequate information about the nature and risk of the securities they recommend to customers, and that relevant information about those securities will be fully disclosed to customers.
Wells Fargo and McMurtry consented to the SEC’s order without admitting or denying the findings. Wells Fargo agreed to pay a $6.5 million penalty, $65,000 in disgorgement, and $16,571.96 in prejudgment interest. McMurtry agreed to be suspended from the securities industry for six months and pay a $25,000 penalty.