The Securities and Exchange Commission has charged Wells Fargo's brokerage firm and a former vice president for selling products tied to mortgage-backed securities without fully understanding their complexity or disclosing the risks to investors.

Wells Fargo has agreed to pay $6.5 million to settle after the SEC found it relied excessively on rating agencies when selling products - a practice now believed to have been a factor in the financial crash in 2008. The money will be placed into a fund for the benefit of harmed investors. The products were sold by Minneapolis-based Wells Fargo Brokerage Services (now Wells Fargo Securities), between January 2007 and August 2007.

The regulator said in a statement that Wells Fargo "improperly" sold asset-backed commercial paper, structured with high-risk mortgage-backed securities and collateralized debt obligations, to municipalities and non-profit institutions. The regulator said that Wells Fargo's representatives failed to grasp the true nature, risks and volatility of the products before recommending them to investors with generally conservative investment objectives. Instead, the firm relied almost exclusively on credit ratings, according to the SEC.

“Broker-dealers must do their homework before recommending complex investments to their customers,” said Elaine Greenberg, chief of the SEC enforcement division’s municipal securities and public pensions unit.

“Municipalities and other non-profit institutions were harmed because Wells Fargo abdicated its fundamental responsibility as a broker to have a reasonable basis for its investment recommendations to customers," Greenberg said.

From AAA to junk

A two-year bipartisan investigation into the causes of the financial crisis by the Permanent Subcommittee on Investigations, released in 2011, concluded that “the most immediate cause of the financial crisis was the July 2007 mass ratings downgrades by Moody’s and Standard & Poor’s that exposed the risky nature of mortgage-related investments that, just months before, the same firms had deemed to be as safe as Treasury bills.”

The report said that over 90 per cent of the triple-A ratings given to mortgage-backed securities in 2006 and 2007 were later downgraded to junk status.

VP charged

The SEC also charged Shawn McMurtry, a former Wells Fargo vice president, for his involvement in improper sales. "McMurtry exercised discretionary authority in violation of Wells Fargo’s internal policy and selected the particular issuer of ABCP for one longstanding municipal customer," the regulator said. "McMurtry did not obtain sufficient information about the investment and relied almost entirely upon its credit rating."

In excess of the $6.5 million penalty, Wells Fargo agreed to pay $65,000 in disgorgement and $16,572 in prejudgment interest.