As Banco Santander SA scrambles to raise funds by shedding assets abroad, it faces a backlash at home from angry customers saddled with some €4 billion ($5.2 billion) of paper losses on risky bonds the bank sold four years ago to fund a landmark takeover.
Hundreds of customers who purchased the bonds, which will automatically convert to common shares in October 2012, say Santander's bankers failed to spell out the investment's risks, according to consumer groups, plaintiffs' lawyers and regulatory complaints.
Spain's securities regulator said in an October report that it detected irregularities, including sales of the bonds before legal documents were filed, but it can't force the bank, Europe's second-largest lender by market value, to repay its clients.
Santander says it complied with all relevant rules for the €7 billion placement, which ranks as the world's largest-ever sale of convertible bonds.
Two individuals already have filed separate lawsuits against Santander seeking full refunds based on alleged disclosure missteps. In addition. Spanish local consumer association Adicae says it is helping 600 bondholders to negotiate a deal with Santander, as part of a broader effort to curtail banks' marketing of "toxic savings products." If those talks fail, the group says it will sue, seeking refunds for investors who were told the complex securities were savings products.
Benita Pedrosa, a 64-year-old widow on an €800-a-month pension, said she invested her life savings in the bonds because her local branch manager assured her the money was safe.
The investment's value declined by more than €30,000, or more than half its value. The bank recently dismissed her request to void the contract, and she said she now plans to complain to regulators.
The complaints by Santander customers echo the reactions of U.S. retail investors who invested in higher-yielding and supposedly safe auction-rate securities.
As the market for these investments froze in early 2008, regulators forced dozens of banks to repurchase tens of billions of dollars' worth of these investments. Now analysts are questioning whether Santander will have to compensate investors.
"The perception is that a significant number of pensioners have no clue what they bought," said Daragh Quinn, a banking analyst with Nomura. "If enough people complain, Santander is in trouble."
The standoff comes as Santander and other European banks face pressure to raise capital amid market tumult. European banking regulators recently instructed Santander to come up with more than €15 billion in new funds. The bank is counting on the issuance of shares tied to the convertible bonds to fill roughly half of the shortfall, while also selling assets in fast-growing Latin American markets.
Santander Chief Executive Alfredo Sáenz recently ruled out any compensation for convertible bondholders. "In essence, they're in the same situation as shareholders," he said on a conference call.
In late 2007, Santander sold the convertible bonds to 129,000 Spanish retail customers to fund its portion of the €72 billion purchase of ABN Amro NV, the Dutch lender that Santander bought along with two other European banks.
Called Valores Santander, the bonds offered a 7.5% interest rate in the first year, and then were set to pay 2.75 percentage points above the European interbank lending rate during the remaining four years. If the bid for ABN failed, Santander would return the cash to clients after a year, giving Valores a deposit-like feature.
But the bid succeeded, and the bonds will automatically convert into shares in October 2012 at a 16% premium to Santander's share price at the beginning of October 2007.
Under those terms, Valores holders stood to profit on the security if Santander's stock rose by at least that much over the next five years. But Santander's shares, which closed at €5.78 Thursday, would need to more than double to €14.13 by October for that to happen.
Spain's securities regulator, CNMV, examined the deal last year after complaints rolled in. It said in October it had "sufficient cause to qualify [Santander's] behavior as incorrect" in 26 cases related to the bond sale, which warranted voiding the sales contracts.
The CNMV can't require the bank to repay its clients, and it can't levy fines in individual cases. It can only refer those investors the courts. The regulator declined to comment on specific cases beyond its October report.
Santander color-coded Valores as a "yellow product," aimed chiefly at wealthy and sophisticated clients. In some cases regular retail-banking clients could buy it, "when the branch worker believes that the product fits their risk profile," according to Santander's internal guidelines.
Ms. Pedrosa, the widow who said she plans to pursue a case with the CNMV, said she didn't fit this profile. She paid €60,000 for bonds that are now worth €24,000.
In several cases, the CNMV found Santander began selling Valores before publishing the prospectus that laid out the bond's key terms and conditions. Sales contracts seen by The Wall Street Journal indicate Santander sold Valores to customers as early as Sept. 6, 2007, almost two weeks before the prospectus was published.
The bank views contracts signed before the prospectus's publication as expressions of interest, not sales orders, according to one person familiar with the sale.
Jorge Segura, a 48-year-old prison therapist, is suing Santander. He wants the bank to return his €45,000 Valores investment partly because he bought the bonds two days before the prospectus's publication.
His case is scheduled to go to trial in March.
Others followed Santander's lead. Spanish banks sold more than €20 billion in convertible bonds and preferred stock to retail customers between 2007 and 2010. Many of these securities also have accumulated steep losses.
"It's always a temptation for a bank to use its client base to place its own securities, but it's at the very limit of what's ethical," because retail clients often aren't savvy enough to carefully weigh the risks, said Carles Vergara, a finance professor at IESE Business School in Madrid.
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