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Wells Fargo Sold Risky Program as Safe, Lawyer Says

Wells Fargo & Co. marketed a risky securities-lending program as safe and ended up causing millions of dollars in losses for institutional investors, a lawyer said as the trial of a lawsuit against the bank began.

“Securities lending was represented by Wells Fargo to be a minimal or no-risk investment,” Mike Ciresi, an attorney for Blue Cross Blue Shield of Minnesota and 11 other plaintiffs, said in his opening statement today in federal court in St. Paul.

The case is one of at least five against Wells Fargo, brought in Minnesota, where the program was based, over its securities lending. The San Francisco-based bank lost the first case to go to trial in 2010, when a state court jury awarded Minnesota Workers’ Compensation Reinsurance Association and three foundations about $30 million. That judgment was upheld on appeal.

Wells Fargo is scheduled for a third trial on the same claims in September in a class action brought by about 100 other institutional investors. Two more cases are pending in federal court, including one by Minnesota Life Insurance Co. seeking $40 million in damages.

Nonprofit Groups

The trial before U.S. District Judge Donovan W. Frank involves allegations by Blue Cross Blue Shield of Minnesota, the El Paso County Retirement Plan and 10 other nonprofit groups seeking reimbursement of losses and punitive damages. A jury of eight women and three men was selected yesterday.

Bart Williams, a lawyer for Wells Fargo, countered in his opening statement that the securities-lending program was a solid, conservative investment that withstood the market’s worst downturns.

“The fact is, the Wells Fargo securities-lending program was a sturdy structure that held up during the crisis of 2008,” he told jurors. “What does conservative mean if not 2.7 percent losses in the worst financial calamity in recent history?”

Under the securities-lending program, Wells Fargo held its clients’ securities in custodial accounts and made temporary loans of the instruments to brokers.

The brokers used the securities to support trading activities such as short sales and option contracts. The clients “had the right to recall their loaned securities at any time, for any reason,” according to the complaint. Brokers borrowing the securities were required to post collateral, primarily cash, to use the instruments, court filings show.

‘Conservative Investments’

“Wells Fargo promised to invest the cash in conservative investments, which Wells Fargo repeatedly represented would be ‘high-grade money market instruments,’ where the ‘prime considerations’ would be ‘safety of principal and liquidity,’” Blue Cross said in court papers filed Sept. 11.

Wells Fargo “heavily invested” the collateral in risky or highly illiquid securities such as structured investment vehicles and mortgage-backed assets. The investors contend that instead of making a small profit, they lost money.

Wells Fargo engaged in “systematic, intentional and unlawful conduct -- including breaches of fiduciary duty, breaches of contract, and fraud,” the plaintiffs said in the complaint.

The alleged misconduct included failure to disclose material information about the investments and a cover-up of wrongful actions, the plaintiffs said. Wells Fargo continued to pursue the investments as they began to falter, they claimed.

Bank Run

“They didn’t want to tell the plaintiffs because they were scared it would cause a run on the bank,” Ciresi told jurors. “They didn’t disclose that their investment approach, by their own admission, was amateurish.”

Wells Fargo has denied the claims, blaming any losses on the financial crisis.

“The allegations made by the plaintiffs are without merit,” Laura Fay, a spokeswoman for the bank, said in an e-mailed statement. “The investments made by Wells Fargo on behalf of clients in the securities-lending program were in accordance with investment guidelines and were highly rated and suitable at the time of purchase.”

The company sold the majority of its securities-lending program to Citigroup Inc. in 2011, Fay said. Wells Fargo remains liable for any damages sought in the lawsuits, she said.

Lehman Investments

Williams acknowledged to jurors today that some funds from the securities-lending program were invested in Lehman Brothers Holdings Inc., which sought bankruptcy protection from creditors in 2008 partly as a result of losses tied to subprime mortgages.

When Wells Fargo officials made the investments, there were “absolutely no indications” the fourth-largest U.S. investment bank would file for Chapter 11 protection, Williams added. The funds were put in “reasonable, safe and conservative investments,” he added.

Lehman was one of the largest underwriters of mortgage-backed securities tied to the U.S. real-estate market. It began a liquidation of its assets as part of the bankruptcy case in New York. The defunct firm is paying creditors in installments it says may total an average of 18 cents on the dollar for their claims.

The Minnesota case is Blue Cross Blue Shield of Minnesota v. Wells Fargo Bank, 11-cv-02529, U.S. District Court, District of Minnesota (St. Paul).

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