Investment deals involving collateral-debt obligations (CDOs) have come back to haunt Wells Fargo & Co. Wells has agreed to pay $11.2 million to settle charges by the Securities and Exchange Commission (SEC) that its Wachovia Capital Markets LLC unit sold CDOs to a Zuni American Indian tribe and other investors at prices 70% higher than its own estimate of the mark-to-market value of the securities.

As reported April 6 by Investment News, the SEC’s complaint alleges that Wachovia failed to inform investors in another CDO that it had transferred 40 residential mortgage-backed securities from an affiliate at above-market prices to avoid losses on its own books.

“Wachovia caused significant losses to the Zuni Indians and other investors by violating basic investor protection rules – don’t charge secret excessive markups and don’t use stale prices when telling buyers that assets are priced at fair market value,” said Robert Khuzami, director of the SEC’s Division of Enforcement, in a statement.

Wells Fargo, without admitting or denying the allegations, will pay restitution of $6.75 million and a $4.45 million penalty. A total of $7.4 million will be returned to investors who were harmed by the misconduct, according to the SEC.

Wells Fargo purchased Wachovia in 2008.

When it comes to financial adviser satisfaction, Morgan Stanley Smith Barney rates at the very bottom of six national broker/dealers, according to a J.D. Power and Associates Survey.

Among independent broker/dealers, the survey says Commonwealth Financial Network came out on top, while MetLife Broker Dealer Group ranked the lowest.

As reported Oct. 24 by Investment News, the 2010 U.S. Financial Advisor Satisfaction Study was based on responses from 2,863 advisers who hold a Series 7 license. The study was conducted in February and March, and again between July and September.

Key areas covered in the survey included adviser satisfaction, firm performance, technology and work environment.

This is the first time that the survey has ranked independent broker/dealers.

Last week, Morgan Stanley was sued by a group of Singapore investors who accused the company of rigging a bond sale related to collateralized debt obligations in order to wipe out their $155 million investment. The notes were issued by Pinnacle Performance Ltd, a Cayman Islands-registered outfit that Morgan Stanley had allegedly marketed as “conservative,” with the goal to protect investors’ principal.

Instead, the investors say Morgan Stanley invested their funds into synthetic CDOs, with the bank itself serving as the counterparty on the underlying swap agreements. The investors allege that the arrangement was structured so that Morgan Stanley would collect one dollar for each dollar they lost.

The admission of guilt came on July 15 as Goldman Sachs settled civil fraud charges with the Securities and Exchange Commission (SEC) over its marketing of a collateralized debt obligations (CDO) package known as Abacus 2007-ACI.

In settling the matter, Goldman agreed to pay a $550 million fine. It is biggest fine ever levied by the SEC on a U.S. financial institution. Goldman also acknowledged that its marketing materials for Abacus contained incomplete information.

“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” says Robert Khuzami, Director of SEC Enforcement.

Goldman’s troubles began back in April, when the SEC accused the investment bank of failing to disclose that one of its clients, Paulson & Co, had helped select the securities contained in the Abacus mortgage portfolio and which was later sold to investors.

According to the SEC, Goldman did not reveal that Paulson, one of the world’s largest hedge funds, had, in fact, bet that the value of the securities would fall.

Following the collapse of the housing market, the securities in that mortgage portfolio – i.e. Abacus – lost more than $1 billion.

Despite the settlement with the SEC, Goldman is far from being out of legal hot water. One of the investors in Abacus was the Royal Bank of Scotland PLC (RBS), which lost $841 million as a result of the deal. Of Goldman’s $550 million settlement with the SEC, approximately $100 million will be paid to RBS. However, the RBS may be considering a civil suit against Goldman Sachs Group to recoup additional financial losses it sustained in Abacus, according to a July 16 article in the Wall Street Journal.

Meanwhile, Fabrice Tourre, who is the only Goldman Sachs executive named as a defendant in the SEC’s fraud lawsuit, has yet to settle with the regulator.

Tourre, the creator of Abacus, has repeatedly denied the SEC’s charges that he misled investors. A number of potentially damaging emails seem to refute Tourre’s claims, however. In one email, Tourre comments on the state of the housing market and the inevitable demise of Abacus:

“More and more leverage in the system. The whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implication of those monstrosities!!!”

The admission of guilt came on July 15 as Goldman Sachs settled civil fraud charges with the Securities and Exchange Commission (SEC) over its marketing of a collateralized debt obligations (CDO) package known as Abacus 2007-ACI.

In settling the matter, Goldman agreed to pay a $550 million fine. It is biggest fine ever levied by the SEC on a U.S. financial institution. Goldman also acknowledged that its marketing materials for Abacus contained incomplete information.

“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” says Robert Khuzami, Director of SEC Enforcement.

Goldman’s troubles began back in April, when the SEC accused the investment bank of failing to disclose that one of its clients, Paulson & Co, had helped select the securities contained in the Abacus mortgage portfolio and which was later sold to investors.

According to the SEC, Goldman did not reveal that Paulson, one of the world’s largest hedge funds, had, in fact, bet that the value of the securities would fall.

Following the collapse of the housing market, the securities in that mortgage portfolio – i.e. Abacus – lost more than $1 billion.

Despite the settlement with the SEC, Goldman is far from being out of legal hot water. One of the investors in Abacus was the Royal Bank of Scotland PLC (RBS), which lost $841 million as a result of the deal. Of Goldman’s $550 million settlement with the SEC, approximately $100 million will be paid to RBS. However, the RBS may be considering a civil suit against Goldman Sachs Group to recoup additional financial losses it sustained in Abacus, according to a July 16 article in the Wall Street Journal.

Meanwhile, Fabrice Tourre, who is the only Goldman Sachs executive named as a defendant in the SEC’s fraud lawsuit, has yet to settle with the regulator.

Tourre, the creator of Abacus, has repeatedly denied the SEC’s charges that he misled investors. A number of potentially damaging emails seem to refute Tourre’s claims, however. In one email, Tourre comments on the state of the housing market and the inevitable demise of Abacus:

“More and more leverage in the system. The whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implication of those monstrosities!!!”

Investment deals involving Magnetar Capital are garnering renewed interest from the Securities and Exchange Commission (SEC), as the regulator steps up its investigation into how hedge funds like Magnetar made huge profits on instruments that produced billions of dollars in losses for investors.

The investments in question are mortgage-related collateralized debt obligations (CDOs). As reported June 19 by the Wall Street Journal, the hedge fund known as Magnetar played a key role in the CDO market, keeping sales growing even as cracks began to appear in the housing market.

Magnetar also worked with most of Wall Street’s top banks in its deals, including Merrill Lynch, Lehman Brothers, Citigroup, UBS and JPMorgan Chase.

Magnetar bought the riskiest portion of CDOs, while simultaneously placing bets that portions of its own deals would fail. Along the way, Magnetar allegedly did something to enhance the chances of that happening. According to an April 10 article by ProPublica, Magnetar pressed to include riskier assets in its CDOs so as to make the investments even more prone to failure.

Apparently Magnetar acknowledges that it bet against its own deals but says the majority of those short positions involved similar CDOs that it did not own. Magnetar says it never selected the assets that went into its CDOs.

The bottom line is Magnetar ended up making big profits when the CDOs collapsed. Meanwhile, investors in the supposedly safer parts of the CDO suffered big losses.

Now the SEC wants to know how the assets that were put into the CDOs were valued at the time, the terms of the deal, what triggers were put in place to determine whether investors would incur losses and at what point did the banks that were involved in the deal bet against the assets in the CDO.

A June 11 blog by the Wall Street Journal illustrates a growing trend on Wall Street – the sophisticated investor defense. The premise is simple: If the complex financial products that Wall Street markets and sells go south, it’s the investor’s problem. After all, the products are geared to those who are financially savvy. They should have therefore known the risks involved.

In reality, even the most sophisticated investor may be unaware of the complexities and risks surrounding some of today’s investments. Moreover, even the “average” investor gets burned in these deals, usually through pension funds that participate in the investments.

A recent case involving Merrill Lynch and collateralized debt obligations (CDOs) is a perfect example. Merrill Lynch’s CDO deals were sold to institutional and retail investors. In other words, so-called sophisticated and less-than-sophisticated investors were part of the sales pitch. It also apparently was common fare for Merrill Lynch to sell retail investors the lowest-rated CDO slices of the deals.

Investors like the Slomacks ultimately paid the price, according to the WSJ article. The Slomacks invested $2.65 million in several Merrill-issued CDOs, losing all but $16,500. They have since filed an arbitration claim against Merrill Lynch with the Financial Industry Regulatory Authority (FINRA).

Another investment firm looking to employ the “sophisticated investor” defense over CDO deals gone bad is Goldman Sachs. For more than a year, Goldman has faced intense questioning by the U.S. Senate Permanent Subcommittee on Investigations about its CDO dealings, while investors contend Goldman used deceptive sales practices to market billions of dollars’ worth of the products. To date, the probes have cost Goldman $25 billion in market capitalization, according to a June 14 article by Reuters.

In April, the Securities and Exchange Commission (SEC) filed a civil fraud lawsuit against Goldman Sachs over a CDO called Abacus 2007. The Abacus transactions were synthetic collateralized debt obligations – financial products that many financial analysts say were largely responsible for the worst collapse in financial markets since the Great Depression.

Merrill Lynch’s sales of risky collateralized debt obligations (CDOs) have come back to haunt Main Street, with many investors alleging they didn’t thoroughly understand the dangers that the complicated products present.

“We were just lambs being led to the slaughter,” said investor Michael Slomak in a June 11 story in the Wall Street Journal.

Slomack is part of a Cleveland family whom he says invested $2.65 million in several Merrill-issued CDOs. According to the WSJ article, the structured securities had a level of risk that was never adequately explained to Slomack and other family members. The family lost all but $16,500 and has since filed arbitration claim against Merrill Lynch with the Financial Industry Regulatory Authority (FINRA),

Merrill Lynch, which is now part of Bank of America, may be especially susceptible to the wrath of investors because it has sold the biggest inventory of CDOs and had the industry’s biggest brokerage force to sell them in the years leading up to the financial crisis. As the Wall Street Journal article points out, it was common practice for Merrill to pitch retail clients the lowest-rated CDO slices while it sold the higher-rated tranches to larger institutions.

At issue in the Merrill case – and in other cases and arbitration claims related to CDO deals – is the idea of investor sophistication. Even though there are certain regulatory rules in place regarding the types of investors who can purchase higher-risk financial products like CDOs, newer investment products have become more complex in recent years. As a result, the complexities and risk levels of these products may not be fully understood by even the most sophisticated retail customer.

Boston businessman Russell Stephens knows this only too well. Stephens, who considers himself a “sophisticated” investor, bought a $400,000 CDO from a Merrill Lynch adviser in Virginia. Stephens, 56, said he was sold the tranche most vulnerable to losses in the event of default, yet was told that the CDO would be an appropriate replacement for a municipal bond. As fate would have it, the CDO hit a wall, and Stephens faced an unexpected tax charge. Ultimately, the value of his investment plummeted to $80,000.

“It’ been a nightmare,” Stephens said in the Wall Street Journal, adding that the deal “wasn’t fully explained” to him.

Lack of disclosure also was a problem for investor Alan Lipson. Lipson lost $20,000 in a Merrill Lynch CDO. He attributes the loss to the fact that he missed a key section of the prospectus, which cited information on how banks that provide the CDO assets could stop paying interest at any time.

For Ralph Cortell, a former Ohio hair salon business owner, the issue regarding his CDO losses was alleged misrepresentation. Cortell, who died in 2008, invested $2.65 million as a nest egg for his four daughters. In late 2004, Cortell and his son-in-law sought the advice of two local Merrill brokers on how they should invest proceeds from the sale of 200 hair salons.

The brokers allegedly assured them that CDOs were “very safe with little or no risk.” Later, a former Merrill Lynch vice president told Cortell to put even more money into CDOs, stating that they had “zero risk.”

A complaint with FINRA is now pending in Cortell’s case.

Goldman Sachs is facing yet another lawsuit involving toxic synthetic collateralized debt obligations (CDOs). Australian hedge fund manager Basis Capital’s Yield Alpha Fund claims it was defrauded by Goldman when it purchased $78 million of the Timberwolf CDOs in June 2007 and that Goldman knew at the time of the sale the securities were destined to fail as the mortgage market began to decline.

Basis Capital is seeking more than $1 billion in damages.

The lawsuit comes on the heels of another fraud lawsuit against Goldman Sachs. In April, the Securities and Exchange Commission (SEC) filed a civil suit against Goldman in connection to the sale of a synthetic CDO known as Abacus. As reported June 9 by the Wall Street Journal, Goldman and the SEC are reportedly working to settle that case, which could cost Goldman between $500 million and $1 billion in fines.

Emails will likely play a central role in the Basis Capital case. According to complaint, one email from a former Goldman executive describes the $1 billion Timberwolf CDO as “one s—-y deal.”

Basis Capital was forced to liquidate the Basis Yield Alpha Fund in late 2007 after sustaining heavy losses betting on the subprime mortgage market, including buying instruments like Timberwolf.

“Goldman was pressuring investors to take the risk of toxic securities off its books with knowingly false sales pitches,” said Eric L. Lewis of Baach Robinson & Lewis PLLC, Basis Yield Alpha Fund’s lead counsel, in the Wall Street Journal article. “Goldman should be called to account for its deception of BYAFM and other investors who were misled.”

Citigroup and Morgan Stanley appear to be taking a lead from Goldman Sachs when it comes to collateralized debt obligations (CDOs). As reported in a May 21 article by Bloomberg, Citigroup is the focus of several inquiries for allegedly selling a series of mortgage-linked securities – known as the Jackson Segregated Portfolio – to investors without disclosing the fact that Morgan Stanley helped shape the investments while also betting they would fail.

According to the Bloomberg article, marketing documents for the products – which were underwritten by Citigroup in 2006 – failed to provide information on the entity responsible for selecting the underlying mortgage bonds. Sources close to the deal contend that the entity was a Morgan Stanley unit. Six of the seven series of Jackson bonds later defaulted, costing investors more than $150 million of losses, according to Bloomberg data.

So far, Citigroup hasn’t been publicly accused of any violations tied to the Jackson deals.

In a similar situation last month, the Securities and Exchange Commission (SEC) accused Goldman Sachs of misleading investors by failing to disclose that the hedge fund, Paulson & Company, had a role in picking securities it then bet against.

As in the Goldman Sachs case, the Jackson Segregated investments involved a synthetic CDO. Derivatives linked to mortgage bonds were pooled together, packaged into new bonds and then sold investors. On the other end of the Jackson derivatives was a “short” investor. Profits were made when the underlying bonds failed.

“To get the deals done, most underwriters of synthetic CDOs initially took the short positions, sometimes with a plan to sell them off later. When Citigroup set up Jackson, it arranged with Morgan Stanley to take over the short positions once the deal closed . . . Citigroup allowed the firm to help select the bonds linked to the derivatives because Morgan Stanley would have a stake in the performance of the securities,” the Bloomberg article reports

Investments deals involving CDOs have come back to haunt Morgan Stanley. Federal prosecutors apparently are investigating whether the investment bank intentionally misled investors about various synthetic collateralized debt obligations that it helped design and sometimes bet against. The story was first reported by the Wall Street Journal on May 11.

According to the story, Morgan Stanley marketed and sold the CDOs in question to investors and then subsequently placed bets that their value would fall. Among other things, investigators want to know whether the bank disclosed certain facts to investors, as well as its role in the deals themselves.

In April, the Securities and Exchange Commission (SEC) charged another investment firm – Goldman Sachs – with fraud in connection to sales of synthetic CDOs.

According to the SEC’s complaint, Goldman Sachs failed to tell investors certain details regarding the financial products, including the fact that a major hedge fund not only selected the securities held by the CDO but also bet against them to fail.

Meanwhile, the probe into Morgan Stanley’s CDO is at a preliminary stage.