It seems a new lawsuit is filed almost every day against financial institutions over their offering of derivatives to clients. Wells Fargo (NYSE:WFC) is the latest recipient of this type of lawsuit, as the California Earthquake Authority has sued them over losses incurred from a CDO named ‘Mainsail 2,’ where they lost almost all their original money they invested in it.
There’s an old adage in the marketing world that a confused mind doesn’t buy, which crosses over into the litigation world, where it seems a confused mind will sue.
Many of those in the financial industry itself who sell these types of investments don’t understand them. And when they’re described or grouped together as one type of investment with several instruments within that grouping, it gets even more confusing. Not only does this get people mad and ready to sue, it gives them some ammunition for the lawsuit, as it can give the appearance of hiding something or having no way of understanding what it is they’re investing in.
What Metwest allegedly did was take all of the money from the California Earthquake Authority given them to invest and put it in a CDO which was which was supposedly back by commercial paper, which ended up being sub-prime mortgages.
This is a complex issue because of how different parties interpret what asset-backed means. Some lawsuits are going forward with that particular issue as the cornerstone of the case. Once that is cleared up in the courts, we could see even more lawsuits if it is found that the securities being offered as being asset-backed really aren’t. The consequences would be devastating to the banking industry but helpful to those looking to be compensated for their losses.
In this particular case against Wells Fargo, at stake is reportedly $62.6 million, which was subject to heavy losses only a couple of weeks after the money was put into the commercial paper by MetWest.
There are other twists and turns in the case as well. The company which issued the CDO wasn’t even approved to sell commercial paper in California: Solent Capital, which operates out of London.
The other issue, also part of a number of unrelated lawsuits, is the timing of when this was done. What is being looked at is whether finanacial institutions invested in the money, knowing there were enormous risks related to the securities at the time they were investing the money.
As you can see, this is a complex and uncertain issue, which will be decided in a number of other lawsuits filed as well.
What the financial institutions are rightly concerned over is whether this will set a precedent for being sued whenever the economy goes bad and people and institutions lose money. It could strangle some major portions of capitalism, but it could also force the banks to be more forthright and go by not only the letter of the law, but the spirit of the law as well.
Many of them like Wells Fargo may have to learn this the hard way.
