The Securities & Exchange Commission (SEC) announced that Wells Fargo Securities LLC 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 (RMBS) as the U.S. housing market was beginning to show signs of distress in late 2006 and early 2007.
The SEC’s order found that Wachovia Capital Markets violated the securities laws in two respects. First, Wachovia Capital Markets charged undisclosed excessive markups in the sale of certain preferred shares or equity of a CDO called Grand Avenue II to the Zuni Indian Tribe and an individual investor. As detailed in the order, Wachovia Capital Markets marked down $5.5 million of equity to 52.7 cents on the dollar after the deal closed and it was unable to find a buyer. Months later, the Zuni Indian Tribe and the individual investor paid 90 and 95 cents on the dollar. Unbeknownst to them, these prices were over 70 percent higher than the price at which the equity had been marked for accounting purposes.
Second, Wachovia Capital Markets misrepresented to investors in a CDO called Longshore 3 that it acquired assets from affiliates “on an arm’s-length basis” and “at fair market prices” when, in fact, 40 RMBS were transferred from an affiliate at above-market prices. Wachovia Capital Markets transferred these assets at stale prices in order to avoid losses on its own books. The SEC’s order does not find that Wachovia Capital Markets acted improperly otherwise in structuring the CDOs or in the way it described the roles played by those involved in the structuring process.
Wachovia Capital Markets has since been renamed Wells Fargo Securities. Wells Fargo Securities agreed to settle the SEC’s charges by paying more than $11 million in disgorgement and penalties, much of which will be returned to harmed investors through a Fair Fund.
“Wachovia caused significant losses to the Zuni Indians and other investors by violating basic investor protection rules—don’t charge secret excessive markups, and don’t use stale prices when telling buyers that assets are priced at fair market value,” said Robert Khuzami, director of the SEC Division of Enforcement.
Kenneth Lench, chief of the SEC Division of Enforcement’s Structured and New Products Unit, said, “We are committed to uncovering misconduct involving complex financial instruments and opaque markets and, where appropriate, compensating defrauded investors for their losses.”
Without admitting or denying the findings, Wells Fargo Securities consented to the entry of an administrative order directing that it cease and desist from committing or causing any violations and any future violations of Section 17(a)(2) and (3) of the Securities Act of 1933. Wells Fargo agreed to pay disgorgement of $6.75 million and a penalty of $4.45 million. A total of $7.4 million of those amounts will be returned to investors pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002.
Brent Mitchell, Jeffrey Leasure, Jason Anthony and Reid A. Muoio, who are members of the Structured and New Products Unit in Washington, D.C., conducted the SEC’s investigation.
