The Securities and Exchange Commission (SEC) issued a press release today announcing that
Wells Fargo Securities LLC [had] agreed to settle charges that Wachovia Capital Markets LLC engaged in misconduct in the sale of two collateralized debt obligations (CDOs) tied to the performance of residential mortgage-backed securities as the U.S. housing market was beginning to show signs of distress in late 2006 and early 2007.The SEC Order against Wells Fargo Securities can be found here. It was found that Wachovia Capital Markets sold a CDO to the Zuni Indian Tribe with excessive mark-ups and deceived investors in another CDO when it told investors that it acquired assets “at an arm’s-length basis” and “at fair market prices” when these assets were transferred at above fair market prices.
A mortgage backed security (MBS) is a debt security whose cash flows come from, and are backed by, the principal and interest payments of borrowers on the mortgage loans. The pooling of mortgages into a debt security is called securitization and is performed by a trust. Mortgages are originated by public and private agencies, they are then securitized into MBS by a trust, and then the MBS is issued to public investors by the trust. An MBS investor is subject to a multitude of risks such as interest rate and prepayment risk (of the mortgage by the borrower) and the credit risk of the borrower.
We have already seen related cases whereby brokerages misrepresent mortgage delinquencies to MBS investors in order to hide the increased downside risks of subprime MBS.
SLCG has written a paper describing the market and history of CMOs (a type of MBS) in the wake of the collapse of Brookstreet Securities and two Bear Stearns hedge funds.