July 7 (Bloomberg) — Wells Fargo & Co. agreed to pay $125 million to settle accusations by investors that the bank misled them about the risks of mortgage-backed securities it sold.

The plaintiffs in the consolidated group case, or class action, include the General Retirement System of Detroit, New Orleans Employees’ Retirement System and other public pensions, according to the proposed settlement filed yesterday in federal court in San Jose, California.

Wells Fargo, the largest U.S. home lender, and several investment banks that underwrote the securities were sued in 2009 over alleged violations of securities laws in connection with sales of $36 billion in mortgage pass-through certificates in 2005 and 2006.

The securities were backed by pools of mortgage loans that Wells Fargo or its affiliates originated or purchased. In 28 offerings, the bank misrepresented the quality of the loans, failing to disclose that it hadn’t followed appropriate underwriting standards and loans were made based on inflated appraisals, investors said in a complaint.

The bank and the underwriters deny wrongdoing, according to the proposed accord, which is subject to a judge’s approval.

“The proposed settlement agreement is a negotiated resolution as to all named defendants and is intended to avoid the distraction and expense of litigation,” Ancel Martinez, a Wells Fargo spokesman, said in a telephone interview.

State Court Claims

The bank still faces claims in state courts in California, Illinois and Indiana filed by individual investors and federal home loan banks seeking to rescind billions of dollars of mortgage-backed securities purchases.

“It’s a very favorable outcome and will be significant for investors,” David Stickney, a lawyer for the plaintiffs, said in a phone interview.

Bank of America Corp. agreed on June 29 to pay $8.5 billion to resolve investor claims over sales of bonds backed by home loans by Countrywide Financial Corp. which it had acquired in 2008. The settlement covers 530 mortgage trusts with an original loan balance of $424 billion, the bank said.

The case is In Re Wells Fargo Mortgage-Backed Certificates Litigation, 09-1376, U.S. District Court, Northern District of California (San Jose).

To contact the reporters on this story: Karen Gullo in San Francisco federal court at kgullo@bloomberg.net.

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net.