Wells Fargo (WFC) faces a second Minnesota trial over claims by institutional investors that the bank marketed a risky securities-lending program as safe and cost them millions of dollars in losses.

The case is one of at least five in Minnesota against Wells Fargo over its securities lending. Wells Fargo lost the first to go to trial in 2010, when a state court jury awarded Minnesota Workers' Compensation Reinsurance Association and three charitable foundations about $30 million, a judgment that was upheld on appeal.

Wells Fargo is scheduled for a third trial on the same claims from different plaintiffs in September, brought as a class action, or group lawsuit on behalf of about 100 institutional investors. Two other cases are also pending in federal court, including one by Minnesota Life Insurance Co. seeking $40 million in damages.

The trial set to begin today before U.S. District Judge Donovan W. Frank in St. Paul covers allegations from Blue Cross Blue Shield of Minnesota, the El Paso County Retirement Plan and 10 other nonprofit groups seeking unspecified millions of dollars in losses plus punitive damages. The suits have been brought in Minnesota, where the Wells Fargo securities-lending program was located.

Wells Fargo engaged in "systematic, intentional and unlawful conduct — including breaches of fiduciary duty, breaches of contract, and fraud — in a multibillion-dollar securities-lending program," lawyers for the plaintiffs said in the complaint.

Improper, Risky

The alleged misconduct included "a pattern of improper investments in risky securities," failure to disclose material information about the investments to the plaintiffs, and a coverup of wrongful actions, the lawyers said. They said Wells Fargo continued to pursue the investments as they began to falter.

"Wells Fargo was a custodian, an agent, a safekeeper of these securities they were going to loan out," Mike Ciresi, a lawyer for the plaintiffs, said at a June 5 pretrial hearing. "Wells Fargo shouldn't have lost any money in this program, and they didn't have to."

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 San Francisco-based bank, said in an e-mailed statement.

'Suitable' Investments

"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," she said.

"Wells Fargo was focused at all times on serving our clients' interests and we worked very hard and responsibly to achieve the best results for all of the participants in the securities-lending program during very difficult economic conditions," Fay said.

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.

Wells Fargo marketed its securities-lending program to its institutional investor clients "as a way to earn marginally higher returns on securities they already owned," lawyers for Blue Cross said in the complaint.

'Free Money'

Securities lending has been traditionally viewed by pension funds and foundations as a low-risk investment.

"At least one Wells Fargo executive described the program as 'free money' and understood that 'most clients' felt the SLP program was risk free," U.S. Magistrate Judge Jeanne J. Graham inSt. Paul said in an August 2012 order allowing the plaintiffs the right to pursue punitive damages.

Under the program, Wells Fargo held its clients' securities in custodial accounts and would make temporary loans of these securities to brokers. The brokers would use these securities to support their 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.

The brokers borrowing the securities posted collateral, primarily cash. "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 lawyers said in court papers filed Sept. 11.

SIVs, Mortgages

Wells Fargo, they claim, "heavily invested" the collateral in risky or highly illiquid securities, such as structured investment vehicles and mortgage-backed assets. Instead of gaining a small profit, the investors lost money, according to the lawsuit.

"Wells Fargo continued its flawed investment strategy even after it knew, or reasonably should have known, that such investments were unsafe and illiquid," the lawyers said in the September complaint.

They also claim that Wells Fargo initially concealed the losses from them and refused to return the borrowed securities when requested. The institutions weren't able to get the securities back unless they paid back the difference between the cost of the collateral and its value at the time exit was requested, the plaintiffs said. More favored Wells Fargo clients were allowed out without paying, they said.

Rate Spread

The lawsuit particularly targets Wells Fargo's investments in structured investment vehicles. SIVs borrowed money by issuing short-term securities, usually commercial paper at low interest rates, the lawyers said. "The SIVs then lent money by buying long-term assets at higher interest rates," earning a profit off the spread between the rates, the lawyers said.

"Because SIVs borrowed short-term but invested long term, their debt frequently became due before the underlying assets matured," according to the lawsuit. "By their very nature SIVs were highly vulnerable and unsustainable in certain economic conditions."

Wells Fargo executives recognized this, the lawyers contend in the complaint, citing published comments from Chief Executive Officer John Stumpf and former Chairman Richard Kovacevich.

"What advantage, what purpose does an SIV serve other than putting something off balance sheet and keeping it from your investors and taking enormous risks?" Stumpf said in a 2008 interview, according to the Blue Cross lawyers.

Cheyne, Stanfield

Two of the SIVs in which Wells Fargo had heavily invested, Cheyne Finance SIV and the Stanfield Victoria SIV, went into default and subsequently into receivership, the plaintiffs' lawyers said.

While the bank warned of deterioration in the subprime sector by December 2006, the securities-lending program continued these investments, the plaintiffs claim. "In January 2007, instead of heeding the warning, the SLP Portfolio Manager advised: 'To get bang in this econ environ — take more risk,'" according to the complaint.

Wells Fargo has argued in court papers that the plaintiffs' claims are barred "under the doctrine of assumption of the risk," according to a Sept. 25 filing by the bank.

The investors have "no actionable claim for damages" because any alleged losses "were offset, in whole or in part, by profits in their accounts with Wells Fargo and profits arising from purchases of other fixed income instruments that would be considered 'unsuitable' according to the plaintiffs' allegations," company lawyers said in the filing.

The plaintiffs were sophisticated investors, Wells Fargo attorney Bart Williams said at the June 5 hearing. In the contracts with the bank subscribing in the program, the investors agreed they had conducted independent investigations and "assured themselves they can survive the loss of the entire investment," he said.

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