The SEC announced on April 5, 2011 that Wells Fargo Securities agreed to a multi-million dollar settlement of charges that one of its units, Wachovia Capital Markets (which is now a part of Wells Fargo), committed securities fraud when it sold the Zuni Indian tribe complex securities known as collateralized debt obligations (CDOs) which are themselves based on residential mortgage backed securities (RMBS).
Investment firms like Wachovia manufactured trillions of dollars of RMBS, much of which became the collateral for CDOs which the firms also sold. As concerns about the residential real estate bubble escalated in 2006 and 2007, CDOs became harder to sell, and firms like Wachovia were stuck with pieces (called “tranches”) of CDOs in their inventories.
Wachovia Capital Markets’ inventory included the lowest level, ultra-risky tranche of a CDO named Grand Avenue II. Wachovia Capital Markets couldn’t unload the tranche and marked down its inventory value to 52.7 cents on the dollar. Under SEC rules, it could only mark up the price by 5% to sell it to a client. However, Wachovia tried to skirt the 5% rule by first selling the CDO to an affiliated company, Wachovia Securities, for 90.5 cents. A day later, Wachovia Securities sold the CDO to the Zuni Indian Tribe, for 95 cents, which is 5% over 90.5 . The SEC obviously viewed the intra-company sale as a ruse to get around the 5% rule—something that is not that hard to do for exotic products like CDOs that don’t trade in open and transparent markets. And just to make matters worse, the CDO at issue went into default in February 2008.
As is typical in SEC settlements, Wells Fargo neither admitted nor denied guilt. In an apparent effort to put some nice spin on the settlement, Wells Fargo’s spokeswoman Mary Eshet said, “The issues presented here were complex, and Wells Fargo is pleased to have resolved this matter with the SEC.”
As Yogi Berra put it so eloquently “This is like déjà vu all over again.” First we have securities prices getting jacked up through straw man transactions—like that hasn’t been done before! And then, of course, there’s the sad story of the economic exploitation of Native Americans. I don’t think this is the first, or last, time for that either.
The real question is how many times the same kinds of tricks were used to sell overpriced CDOs to other clients in 2007, when Wall Street was desperate to get rid of billions of dollars of CDO inventories that were decomposing like road kill on a Texas highway.