SEC at work (photo: swanksalot)

The SEC has entered into a settlement agreement with Wells Fargo over sales of real estate mortgage-backed securities by Wachovia, which Wells Fargo acquired in the Great Crash of 2008.. The Order [.pdf] requires Wells Fargo to pay $6.75 million back to the investors, and to pay a civil fine of $4.45 million, but naturally, there are no criminal charges. In fact, Wells Fargo wasn’t even required to admit wrong-doing. It’s only negligence after all.

Or was it? The Order recites that Wachovia sold an RMBS named Grand Avenue II in October, 2006. It was not able to sell some preferred shares, and retained those on its own books. Under Generally Accepted Accounting Principles, Wachovia was required to carry the preferred shares at a price at which they could be sold in a reasonably short period. Wachovia marked them at 52.7% of par. In February and March of 2007, Wachovia sold them to the Zuni Indian Tribe and an individual investor at 90% and 95% of par. The investors did not know of the 70% markup.

The Order explains the law:

Under the so-called “shingle theory,” a broker-dealer violates the antifraud provisions of the federal securities laws by charging customers excessive undisclosed markups. A markup is the difference between the price charged the customer and the prevailing market price. A markup is excessive if it bears no reasonable relation to the prevailing market price. (cites omitted)

The Order says that Wachovia knew about the unreasonable mark-ups. The part of the bank that held the preferred shares sold them to the brokerage part of the bank at inflated prices. The brokerage part marked them up 5% on top of that. The total mark-up is in the range of 60-70%. The Order explains that this is called “negligence”. They must have changed the meaning of that term since I went to law school.

In the Order, Wells Fargo got slapped on the wrist for another non-disclosure. Here’s how it worked. Before you can set up an RMBS, you have to get your loans and other assets together. Wachovia holds the portfolio as it gets ready to sell. The value of the assets might drop (or increase) before the securitization, and that loss (or gain) goes to Wachovia. In the Longshore 3 case, Wachovia bought a portfolio of assets for $250 million. Before the securitization was organized, the value of the assets fell $4.6 million, according to the Order.

A Wachovia subsidiary named Structured Asset Investors, LLC, managed the portfolio. SAI employees wanted assurances about the value of the assets, because of the risk that the values had dropped. Wachovia had a Committee to consider such matters. It approved the transfer at $250 million, but required disclosure to investors related to asset pricing. The disclosures were not made.

This was negligence, under a definition with which I was not previously familiar.

Edward Wyatt of the New York Times noticed that no individuals were even named in the settlement, and asked about it. Good on him, and good on him for providing a link to the Order. Lorin L. Reisner, deputy director of the S.E.C.’s enforcement division, said that we should assume that the SEC looked very carefully at the involvement of individuals. Reisner won’t say why no one was even named, let alone prosecuted. Let’s hope he was at least slightly embarrassed that Wyatt noticed that once again the SEC engaged in ritual wrist-slapping as befits their role as pretend watchdog, and put it in the newspaper. Wyatt also called Wells Fargo, whose spokesperson, Mary Eshet, had no comment on whether the people involved in these transactions were still with the bank.

The rest of the business press seems to have stopped after reading the SEC and Wells Fargo press releases. Here is some chest-thumping from the undeserving SEC guy:

Kenneth Lench, Chief of the SEC Division of Enforcement’s Structured and New Products Unit, added, “We are committed to uncovering misconduct involving complex financial instruments and opaque markets and, where appropriate, compensating defrauded investors for their losses.”

If this is the best they can do, no one will miss the Structured and New Products Unit when the government shuts down.