The state of California accused Wells Fargo & Co. of fraud Thursday for the company's role in an investment meltdown that has been compared to the Bernard Madoff scandal in magnitude.
Atty. Gen. Jerry Brown sued three Wells Fargo investment subsidiaries, alleging they committed securities fraud by telling California investors that $1.5 billion of risky securities sold to them were as safe as cash.
The securities "were sold to customers on the basis that they were like cash and people could get their money back in eight days," Brown said in an interview. "Now, it turns out they were not like cash and people can't get their money back even after many, many months, and they're mad as hell."
The lawsuit, filed in state court in San Francisco, seeks to recover the money invested by about 2,400 Californians in what are known as auction-rate securities marketed by the Wells Fargo subsidiaries.
Auction-rate securities, generally backed by student loans, municipal bonds or other debt, have interest rates that are reset periodically through auctions -- sometimes as often as once a week. More than $330 billion of the securities were sold in recent years to investors attracted to their yields, which could be a percentage point or more above a typical money market fund.
Regulators have alleged that many banks and investment firms deceived their clients into believing that auction-rate securities were as safe as a money market account. But when the market for auction-rate securities collapsed in February 2008, many investors couldn't sell the securities, or could sell them only at a loss.
"Auction-rate preferred securities is the largest fraud ever perpetuated by Wall Street on investors," said Harry Newton, a private investor who operates the AuctionRatePreferreds.org website. "It dwarfs all frauds in history, including Madoff."
Several financial-service companies that issued auction-rate debt have agreed to repurchase billions of dollars of the devalued securities to settle claims by regulators that they defrauded investors.
Last month, Wachovia Corp., which Wells Fargo acquired last year, agreed to repurchase $1.5 billion of the securities from California investors in a settlement with the state Department of Corporations that also included a division of Citigroup Inc. Brown said that case didn't involve the securities at issue in the lawsuit he filed Thursday.
Brown's lawsuit names Wells Fargo Investments, Wells Fargo Brokerage Services and Wells Fargo Institutional Services as defendants. It alleges that they began selling auction-rate securities in 2001 and continued to sell them right up to the collapse of the market last year, despite signs that the market was beginning to crack in the second half of 2007.
The state alleges that Wells Fargo sales personnel weren't properly trained in the intricacies of auction-rate securities, and that the risks of the investments weren't explained to clients. Investors included retirees and small businesses, and accounts ranged from $25,000 into the millions of dollars, the suit says.
In one case cited by Brown, a Bay Area company shifted $400,000 in working capital from a money market account to auction-rate securities. The business intended to use the money to expand, according to the attorney general's office, but when the auction-rate market failed, the company couldn't access the money and instead was forced to lay off workers.
San Francisco-based Wells Fargo disputed the state's allegations, saying it had taken steps to help customers hit by the collapse of the auction-rate market, including offering loans to tide them over.
"We fully understand and deeply regret the effects this prolonged liquidity crisis has had on our clients," Charles W. Daggs, chief executive of Wells Fargo Investments, said in a statement.
"Wells Fargo could not have predicted these extraordinary circumstances, and even with the benefit of hindsight is not responsible for them."
Wells Fargo also is facing similar action from the state of Washington.
Andrew Stoltmann, a Chicago attorney representing several auction-rate securities investors with claims against brokerage firms, said it was "unfortunate that it's taken as long as it has for the California attorney general to act on this issue, but better late than never."
A spokesman for Brown said, "We try to be careful in doing our work and bringing the strongest possible case."