An expensive teachable moment for Wells Fargo's leaders

The Wells Fargo brass should be relieved that a Ramsey County jury this week rejected the big-ticket punitive-damages argument made by nonprofit clients who claimed the big bank's securities lending unit bilked them.

The jury's verdict award of $29.9 million in compensatory damages plus the findings that Wells Fargo & Co. engaged in consumer fraud and breached its fiduciary duty should be regarded as an embarrassing lesson for the San Francisco-based giant. Although the financial impact to Wells Fargo is negligible, the short-term hit to its reputation is significant.

"They were sloppy, but they weren't out to [deliberately] defraud their customers," summarized Prof. Andrew Winton, head of the banking and finance department at the Carlson School of Management at the University of Minnesota. "We've seen this before. A bunch of money that was in money market funds is invested in mortgage-backed funds. It's significant that the jury found against Wells Fargo for double the estimated loss. There is some responsibility if you are going to take on something that is not plain-vanilla, short-term Treasury bonds. You must communicate that uncertainty, that risk [to clients]."

Short of a successful Wells Fargo appeal of the jury's verdict, expect similar settlements at financial institutions around the country that find themselves in the same situation.

Mike Ciresi, attorney for the four nonprofits that sued Wells Fargo, including his own firm's children's foundation, argued that the jury had a chance to shake the financial world with a $100 million-plus damages award that would "send a message to prevent this conduct from happening again."

And there were some very embarrassing Wells Fargo management e-mails about the customers getting shafted as the mortgage market plunged in 2007-08, ultimately sparking a worldwide financial collapse and the global recession.

But juror Susan Lundy said Thursday: "We just did not have enough evidence that this was an extraordinary situation" that warranted additional damages.

Wells Fargo argued that both the bank and its clients were the victims of an unforeseen financial market collapse.

Under securities lending, brokerages lend stocks owned by clients to large investors who use the shares for short sales and other specialized trading. In exchange for the loaned shares, the brokers hand over cash collateral. The securities-investment unit invests the client cash. The charities claimed they were led to believe they were in risk-free, short-term debt. Wells Fargo argued that they knew there was investment risk.

John Stumpf, the Wells Fargo CEO, testified he didn't know what the little securities-lending unit was doing. Fact is, this was a little piece of the mortgage-market debacle that led the financial system to implode and prompted the federal bailout.

From the hundreds of independent mortgage brokers on up to huge Citigroup and Merrill Lynch, the system turned what was a niche product called a subprime mortgage into a mainstay, relaxed their underwriting requirements to grab market share, then jammed the pipeline with risky loans. And everyone acted as if the housing prices would never fall.

It was all done with the full complicity of Federal Reserve Chairman Alan Greenspan, that champion of unregulated markets, who now says he was mistaken.