Wells Fargo's defense: Client came first

Wells Fargo & Co. went into full-fledged damage control when the credit markets collapsed in the middle of 2007 and clients in the bank's specialized securities lending program found some of their investments in unexpected trouble.

"We were under a tremendous amount of stress because of the market conditions," Robert Smith, the then-managing director of securities lending for Wells Fargo, testified Thursday. "We were working 70-hour workweeks and on Saturday and Sunday to make sure the client got what it needed."

Smith made his comments as Wells Fargo began to mount its defense in a three-week-old trial in Ramsey County District Court in St. Paul. Four Minnesota nonprofits sued the bank over losses they incurred in 2007 and 2008 when financial markets roiled with uncertainty.

"We had department meetings every day," Smith said. "We wanted to know what was strong, what was weak, where there were opportunities. We wanted to make sure that all the clients were treated fairly and got all the information they needed."

The four nonprofits, including three charities, accuse Wells Fargo of mishandling the securities lending program by putting risky items in the investment portfolio, including structured investment vehicles (SIVs) whose assets include subprime mortgages that proved volatile.

The Minneapolis Foundation, the Minnesota Medical Foundation, the Robins Kaplan Miller & Ciresi Foundation for Children and the Minnesota Worker's Compensation Reinsurance Association are seeking $407 million in damages.

Lucinda Hruska-Claeys, risk manager for the lending program, testified that the bank provided each client in the program with monthly, quarterly and annual updates about market conditions and the state of the client's investment.

"It made a profit every year until 2007," Hruska-Claeys testified.

Trouble began, she acknowledged, when two SIVs that were in the securities lending portfolio went into default and broker Lehman Brothers went bankrupt.

Lehman was one of the top 10 borrowers in the securities lending program, which borrowed shares of stock from program clients in exchange for cash collateral. Brokers used the loaned stock to conduct stock transactions, and Wells Fargo used the pooled cash collateral to make small profits for clients while the stock was on loan.

The defaults and bankruptcy caused the program's $10 share price to fall below that number, sending off red flags to participants.

"We were having many conversations with our clients in November 2007," Hruska-Claeys said. "It's fair to say" no one was happy.

"I was surprised," Minnesota Medical Foundation Vice President Cynthia Kaiser said when she learned of the first SIV default, which cost the foundation $354,000. "That was a stunning loss."

Don Swanson, vice president of finance for the reinsurance association, said the organization faced a $4 million loss with the 2007 SIV default. The losses would later grow to nearly $12 million.

"I didn't even know what an SIV was," Swanson testified. "We believed [securities lending] to be stable, like a money market investment program."

Swanson called it "a nightmare" when the association tried to leave the securities lending program and get Wells Fargo to cover the investment losses.

"We believed Wells Fargo had a responsibility to make good on those loans," Swanson said.

Swanson's boss, CEO Carl Cummins, said that he and Howard Bicker, director of the state Board of Investment and the reinsurance association's investment committee, asked for a meeting with top Wells Fargo officials at the bank's San Francisco headquarters but were denied.

"Wells Fargo took actions to protect their interests, not our interest," Cummins testified.