Wells Fargo & Co. (WFC) has agreed to settle charges related to the sale of two collateralized debt obligations (CDOs) with the Securities and Exchange Commission (SEC). The CDOs were sold by Wachovia Capital Markets LLC, a company that Wells Fargo acquired in 2008.
According to the SEC, Wachovia has been found guilty of misconduct with regard to the sale of the CDOs, which were linked with the performance of residential mortgage-backed securities in late 2006 and early 2007.
Wells Fargo settled the allegations without admitting or denying them.Wells Fargo will pay over $11 million to the SEC for the settlement, which includes a disgorgement of $6.75 million and a penalty of $4.45 million. Of the total amount, around $7.4 million will be returned to investors pursuant to Fair Fund provisions of the Sarbanes-Oxley Act of 2002.
Charges in Detail
According to the SEC, securities laws were violated in two circumstances by Wachovia. In the first instance, Wachovia charged undisclosed 70% excessive markups in the saleof a CDO called Grand Avenue II to the Zuni Indian Tribe and an individual investor.
The second case was when Wachovia misrepresented by misrepresented to investors in a CDO called Longshore 3. Though Wachovia argued that assets from affiliates were acquired at fair market prices, in reality, 40 residential mortgage-backed securities were transferred from an affiliate at above-market prices. The transfer was done at stale prices so as to evade losses on its own books. However, the SEC did not find any other improper act in the way the company structured the CDOs.
Our Take
SEC has stepped up its investigation on Wall Street companies over the sale of CDOs that were responsible for significant losses to investors and the financial crisis. While attractive deals resulted in a surge in demand for the subprime mortgages, which were risky and were underlying scores of bonds, the housing bubble burst led to a slump in the value of bonds thereby resulting in significant losses to investors.
Besides Wells Fargo, last year the SEC and Goldman Sachs Group Inc. (GS) settled a $550 million claim over CDOs. Goldman was charged for its failure to provide key information in marketing materials for a CDO to its investors.
We believe that with its diverse geographic and business mix, Wells Fargo is well positioned compared with its peers. The Wachovia acquisition and the demise of some smaller players helped it garnera larger share in the mortgage markets. Yet, the recent financial regulations are expected to have a negative impact on both top and bottom-line results of Wells Fargo. Besides, costs associated with loan resolutions and loss mitigations are also expected to remain elevated in the near term.
Wells Fargocurrently retains a Zacks #3 Rank, implying a short-term ‘Hold’ recommendation. Considering the stock fundamentals we reiterate our long-term “Neutral” recommendation.
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