[ by Melanie Gretchen and Howard Haykin] The SEC sanctioned Wells Fargo's broker-dealer and a former VP for selling investments tied to mortgage-backed securities to very vulnerable customers.  But what should the SEC have expected:  neither the firm nor its representatives understood what they were selling.

After all, WFC improperly sold ABCP's structured with high-risk MBS's and CDOs to municipalities, non-profit institutions, and other customers.

TRANSLATION: After all, Wells Fargo improperly sold Asset-Backed Commercial Paper structured with high-risk Mortgage-Backed Securities and Collateralized Debt Obligations ...

Needless to say, the institutional customers held conservative investment objectives. Individual Named in the Case. Shawn McMurtry was held individually accountable for his violation of Wells Fargo’s internal policy and selected the particular issuer of ABCP for one longstanding municipal customer. SEC Findings and Allegations. Between January 2007 and August 2007, RRs in Wells Fargo’s Institutional Brokerage and Sales Division recommended that its institutional customers purchase ABCP issued by limited purpose companies called structured investment vehicles ("SIVs") and "SIV-Lites" backed largely by mortgage-backed securities and CDOs.  These buyers included municipalities, non-profit institutions, and other customers, according to SEC’s order instituting settled administrative proceedings against Minneapolis-based Wells Fargo Brokerage Services (now Wells Fargo Securities), In the eyes of the SEC, 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 specifically found, the following:

• Wells Fargo and its RRs 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.
• The SF-based bank failed to establish any procedures to ensure that its personnel adequately reviewed and understood the nature and risks of these commercial paper programs.
• They further failed to disclose to customers the risks associated with the complex SIV-issued ABCP investments, including the nature and volatility of the underlying assets.

The above failures and negligent actions resulted in substantial losses for those customers who purchased the SIV-issued ABCP - after 3 such investment programs defaulted in 2007. SEC Sanctions. Without admitting or denying the findings, Wells Fargo and McMurtry agreed to settle the SEC charges.  The bank will pay a $6.5 million penalty, to be placed into a Fair Fund for the benefit of harmed investors, plus $65K in disgorgement and $17K in prejudgment interest. McMurtry agreed to a 6-month suspension from the industry and to a $25K penalty.  He exercised discretionary authority in violation of Wells Fargo’s internal policy and selected the particular issuer of ABCP for one longstanding municipal customer.  The SEC found he did not obtain sufficient information about the investment and relied almost entirely upon its credit rating, for which he will be suspended from the securities industry for 6 months and pay a $25,000 penalty.

"Broker-dealers must do their homework before recommending complex investments to their customers.  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." -- Elaine C. Greenberg, Chief of SEC Enforcement, Municipal Securities and Public Pensions Unit.

For further details, go to [SEC PR 12-155, 8/14/12] and the [SEC Order].