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Friday, December 24, 2010

Fraud Ruling Against Wells Fargo in Minnesota Points to Widespread Abuses in

Securities Lending Program

A fraud and breach of fiduciary duty ruling against Wells Fargo in a major scandal in Minnesota may have much

broader ramifications for this sanctimonious bank.

The facts are not pretty. Wells Fargo , in its investment management operation, used securities lending to boost returns

But the returns it increased appeared to be only those of the bank. Institutional investors in various programs lost money

as a result of this activity. Four Minnesota plaintiffs, including two of the states high profile charities, sued. A jury had

already awarded the plaintiffs $29.9 million for fraud. A post trial ruling by the judge has added costs, interest, and

reimbursement of fees that looks set to more than $15 million to the total.

District Judge M. Michael Monahan concurred with the jurys main findings:

Wells Fargo breached its duty of full disclosure by not adequately disclosing that it was changing the risk

profile of the securities lending program, that it breached its duty of impartiality by favoring certain

participants over other participants, and that it breached its duty of loyalty by advancing the interest of the

borrowing brokers to the detriment of one or more of the plaintiffs.

What makes this ruling interesting is that although it set aside a minor part of the jury award, a $1.6 million issue, to be

subject to a new trial, is that it was punitive as a result of the judges determination that the fraud was systematic. It is

unusual to award the payment of the plaintiffs attorneys fees, or to order disgorgement of fees paid for services (the

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other component of the additional $15 million plus is interest on the $29.9 million). The basis for awarding attorneys

fees? The bank is such a menace to society that having counsel root it out is a public service. From the Minneapolis Star

Tribune (hat tip reader Ted L):

The judge said that the nonprofits lawyers, led by Minneapolis litigator Mike Ciresi, provided a public

benefit by bringing the banks wrongdoing to light. Thus, Monahan said, the bank must pay the plaintiffs

attorneys fees and costs, which Ciresis firm estimated at more than $15 million

Terry Fruth, a Minneapolis attorney who has been watching the case closely on behalf of his clients, saidMonahans post-trial order could help other investors prove similar claims against the bank.

The judge didnt just find that Wells Fargo acted with disregard to the rights and interests of the particular

plaintiffs, Fruth said of Monahan. He said the way it ran the program was with disregard to the rights of

the customers. He has made a finding that is going to bind Wells Fargo in other cases.

The judge also seems to understand full well how banking works in America:

Wells Fargo Chairman and CEO John Stumpf and retired Chairman Richard Kovacevich said they

knew nothing about problems in the securities-lending program in 2007. Stumpf said he didnt know the

bank even had such a program.

Monahan said that he found the executives statements to be almost childlike and that he accepts that

one of the primary functions of subordinates in todays corporate America is to shield their ultimate

superiors from accumulating embarrassing information.

Wells Fargo was fully aware of the increased risk it was injecting into the securities lending program, that

its line managers were not reasonably managing that risk, and that its actions and inactions had the potential

for inflicting enormous harm on plaintiffs.

When the program got into trouble, the judge said, Wells Fargos attitude and conduct was primarily

to shield itself, and its favored customers, from the consequences.

Weve been told that investors are afraid to sue banks, fearing that they will be cut off from information (query what

value that information really has in reasonably efficient markets, particularly when the use of such information is to induce

customers to make more trades). Investment management clients are in a somewhat different position, in that they are

not actively managing their accounts and are not limited to going to a relatively small number of dealer banks for

transaction execution (the asset management business is far less concentrated and more diverse). Nevertheless, findings

like these may embolden heretofore more cautious institutional investors to seek to recoup losses when they think their

bank had abused them.

Topics: Banking industry, Corporate governance, Investment management, Legal

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December 24, 2010 at 6:36 am

The full opinion may be found at :

http://stmedia.startribune.com/documents/Wells+Fargo+ruling.pdf?

elr=KArks:DCiU1OiP:DiiUiacyKUbPi87EK_g:D_GD7EaDh_0c:aD:aUr

bidrec says:

December 28, 2010 at 10:05 am

42. c. The difficulty with the program became apparent in 2007. This action commenced in October 2008. It is

arguable that the improper conduct continues as Wells Fargo is still holding Plaintiffs securities and continued to

lend those securities over the objections of their owners. p20

In other circumstances this is Standing Operating Procedure.

The Bank now proposes to act in the capacity of a conduit lender to provide additional return enhancements

to its securities lending customers. Currently, the Banks customer chooses various potential borrowers from a lis

of usual borrowers. However, the customer may decide not to approve all of the borrowers on the list, resultingin some customers that will not permit their securities to be lent directly to certain borrowers. Yet, a certain

borrower may desire to borrow securities that only may be found in accounts of customers that have not

approved the borrower. To engage in the conduit lending services, the Bank would borrow the desired securities

as principal from the customer that had declined to approve the borrower, and then on-lend those same securities

as principal to the borrower.

http://www.occ.gov/static/interpretations-and-precedents/may05/int1026.pdf

anonymous says:

December 24, 2010 at 7:42 am

Wells Fargo is not the angel it pretends to be!

Remember a few years ago the Wells exec who moved into a house they had foreclosed on in Malibu? (a fringe

benefit?)

Theres still corruption in that dept Insider favoritism, pay-offs, shadow buyers, etc. affecting short sales,

foreclosures, evictions, etc.

Their problems arent only in investment and securitization.

Mr. Stumpfs ignorance is his bliss for the time being.

Billy Bob says:

December 24, 2010 at 9:37 am

Monahan said that he found the executives statements to be almost childlike and that he accepts that one of the

primary functions of subordinates in todays corporate America is to shield their ultimate superiors from accumulating

embarrassing information.

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For years now I have been enjoying the disconnect between the Supermanagers we see worshipped in the pages of the

WSJ and various business gazettes giants whose knowledge and command bestride the continents and the years

and the Meremanagers who are called in front of legislative hearings and juries and suddenly appear to know almost

nothing about their businesses, how they are run, what they do, etc. If these people know so little about their businesses

how can boards possibly justify giving them such huge compensation packages?

I will always remember with profound pleasure the testimony of poor persecuted Bernie Ebbers, CEO of Worldcom, a

mere gym teacher who, despite enormous remuneration did not seem to know anything about anything, but really

wanted to help folks with his aw shucks / gee whiz testimony. These people belong in prison, where, after having theirmoney taken from them and restored to shareholders and customers they bilked, they will be able to explore alternative

lifestyle arrangements.

PQSsays:

December 24, 2010 at 12:03 pm

You took the words right out of my mouth.

Why more Americans (who, after all, largely WORK in corporate America) havent figured out how this scam

works, Ill never understand.

Ive seen the protect the higher ups/promote the idiots routine for years and years and been disgusted by it for

just as long. Especially when times get even a little tight and suddenly those of us in the galley are told to pay

more for insurance, get less in our paychecks, and generally accept a short stick in order to stay employed.

Meanwhile, some VP/Corner Office Denizen gets demoted to Hawaii or some other hardship tour.

Bob says:

December 25, 2010 at 12:54 am

Americans who work in corporate America? Do you forget wells Fargo is one of the top employers in the

country. Something like one in 500 people work there. This news wont make for good Christmas news

for a lot of hard working families and innocent stockholders

deeringothamnus says:

December 24, 2010 at 10:39 am

This is all part of the dynastic cycle normal to the human condition. Consider ancient China. Virtuous regimes take over

from corrupt ones, and once in power, themselves become corrupt and are overthrown, in a repeating cycle. This

happens because elites are by nature exclusive, eventually excluding both the genes and ideas needed to preventinbreeding. In ancient China, the victors would kill them and their families down to the third level. The same thing has

happened in any number of places and times ,such as revolutionary France, Bolshevik Russia, Ruanda, etc. . I therefore

fear for our elite ruling class, and might offer to hide some of them in my basement some day.

Billy Bob says:

December 24, 2010 at 3:38 pm

I think of the Bush family, daddy an athlete and wartimepilot; junior a cheerleader and pretend pilot; and the

Bush girls who appear to be normal young women whose main talent appears to be the Butt Dance.

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