Earlier this week, the SEC charged Wells Fargo's brokerage firm with selling complex securities to institutional investors such as municipalities and non-profits. The Institutional Brokerage and Sales Division, between January 2007 and August 2007, made recommendations to institutional clients to purchase asset-backed commercial paper "issued by limited purpose companies called structured investment vehicles (SIVs) and SIV-Lites backed largely by mortgage-backed securities and CDOs." Already this order (PDF) is receiving substantial attention in the press and in the blogosphere.
Of course, this is not the first time a municipality has been put through the ringer by entering into a deal they didn't understand. What makes this case perhaps particularly insidious is that the registered representatives didn't even perform their due diligence before, or have reasonable basis for, suggesting the investments. According to the release:
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.Clearly basing any affirmative investment recommendation almost solely on a single number or rating is reckless and irresponsible. A deeper analysis of proposed investment is required by both the investor and the broker advocating for a particular investment.
This time, Wells Fargo skated away without losing their shirt -- fined less than 0.05% of their profit for last year. Hopefully the SEC is able to garner more significant penalties in the future as they pursue the those that use complex instruments to reap large profits from unknowing investors.