AG Brown: Wells Fargo Pulled $1B Fraud (California Sues Bank)

State Attorney General Jerry Brown has announced he has filed suit in San Francisco Superior Court to recover $1.5 billion he says was fraudulently solicited from California investors in Wells Fargo Bank.

State Attorney General Jerry Brown today announced he has filed suit in San Francisco Superior Court to recover more than $1 billion he says was fraudulently... Brown claims more than 2,000 California investors were victimized by bank sales employees who, up until the fall of 2008, had marketed Wells Fargo auction-rate debt securities and auction-rate preferred securities as liquid, or available to be exchanged for cash at any time. Brown, speaking to reporters gathered in downtown San Francisco, admitted that he, himself, also bought some of the securities. Wells Fargo released a statement denying the charges, saying it will vigorously defend itself. Wells Fargo shares moved higher throughout the day. "These securities were marketed as liquid," Brown said, adding that customers had no idea their money would be locked up. "These customers are still waiting for their money."

Not willing to expand on many details of the case, Brown said he will be seeking to recover nearly $2 billion invested in these bank securities nationwide. He said misrepresentation of financial products on the part of institutions selling them t

Auction-rate securities were a scam against both states/municipalities and the retail investors to whom they were sold.

First, what is an “auction rate security?” OK, let’s get that out of the way:

http://en.wikipedia.org/wiki/Auction_rate_security

This is a pretty fair description of what is going on there.

OK, so what happened that made the banks’ behavior criminal?

The banks did not disclose, either to the municipalities who were the creditors of ARS, nor the buyers of ARS, how large a role the banks/brokers/dealers played in making the market for ARS. Basically, it came down to this: as soon as the banks pulled back from the ARS auctions, the ARS auctions started to fail, which quickly made them into illiquid investments.

For retail (and some state/pension funds), ARS were represented as a “cash alternative” to a money market fund, ie, a way to gain a little more yield on money where the investor needed liquidity and safety.

When the banks started to bleed money off their balance sheets into losses on RMBS, the banks could no longer play the role in the ARS dutch auctions. As a result, two things happened:

1. The issuers of some ARS had to pay the “failed auction yield” on the bonds - which might have been as high as 12 to 15%. This blew a hole into the budget of more than one municipality who did not expect the “failed auction yield” to ever be invoked

2. Investors in the ARS found that they could not convert their ARS positions to real cash (ie, the kind of money you can fold and put into your pocket) without taking very substantial losses.

My plain reading of the securities law is that when a bank/broker/dealer advertises a security as “cash equivalent” - and it is NOT cash, just about anything other than short-term T-bills does not meet the requirements for a cash equivalent - ie, able to be liquidated at ANY time, under ANY market conditions for 100% of the principle investment. Cash has a zero to negative return (in a no-inflation and inflationary environment, respectively), so any security that has a return greater than or equal to zero can be “cash equivalent” in the comparison on returns. THE critical factor is: a) can you access your money at ANY time? b) can you get all of it back that you put into it?

For ARS, the answer is “Yes, until...” and the “until...” is “until the banks no longer rig the market to look much more liquid and deep than it really is. Once the banks step back and quit rigging the market for their own securities, suddenly the investor (and the debtor) find out that these are very thinly traded securities, with very dire consequences for both the debtor and investor.

The banks/brokers/dealers knowingly and materially misrepresented these securities as something they are clearly not, which is a clear violation of the Securities Act of 1934. The speed with which various banks/dealers/brokers paid up and settled the ARS cases brought against them by MO, MA, NY — tells me that the banks knew they were going to lose in court, and lose big.

I wish that the various state AG’s had not allowed the banks to settle, and instead had gone after them for criminal charges of violations of the law. Due to the timing of the issue, it would have set a VERY different tone going into September/October/November for us, the US taxpayer. The banks would have been on notice that they did not own the government, and that the taxpayers weren’t going to play nice.

Thanks for the explanation, it was a type of security and market I was not familiar with.

It seems to me that older generations of economists, of 100 and 200 years ago, understood that “profit” of a bank is/or should be relatively small, because, in theory, they are in the business of holding and protecting the assets of others, while collecting a little interest for those services.

So much of the modern “financial services industry” has made that industry one of the most profitable (at least until recently) AND THE most corrupt and leveraged industry in the economy; because it - banking - is always NOT about CREATING wealth but on making money on the wealth deposited to them in the accounts of others.

Obama does not represent an ounce of “change” in this matter and is even more entrenched in the “financial system” than the worst Leftie could have ever imagined of Bush.

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