The 8th U.S. Circuit Court of Appeals has affirmed a ruling out of the U.S. District Court for the District of Minnesota. Assuming there will not be a successful Supreme Court appeal, the ruling brings to a close a set of complex stock-drop lawsuits filed against Wells Fargo by its own employees.
The underlying lawsuit was filed by participants in Wells Fargo’s retirement program. It relates to the firm’s difficulties in recent years with problematic sales practices in the personal banking side of its business.
The allegations in the suit follow the classic pattern of so-called “stock drop” litigation. By way of background, negative media reports and Congressional inquiries plagued Wells Fargo’s personal banking wing for several years, starting in late summer 2016. According to contemporaneous news reports and the admissions of now-ousted CEO and Chairman John Stumpf, the company’s aggressive sales requirements for low-level banking professionals directly inspired the opening of millions of unauthorized customer accounts. This resulted in a major backlash against the company that has cut roughly 12% to 15% of Wells Fargo stock’s value. The company faced separate civil penalties approaching $200 million.
Ruling on the first version of the complaint, which was consolidated with a second lawsuit filed by another set of Wells Fargo employees in the same venue, U.S. District Judge Patrick J. Schiltz disagreed that Wells Fargo fiduciaries violated their duties of prudence and loyalty under the Employee Retirement Income Security Act (ERISA) by keeping company stock as an investment in its 401(k) plan when, plaintiffs alleged, plan fiduciaries knew the stock price was inflated.
In ruling on both the original complaint and the amended complaint, Schiltz relied on the pleading standards set forth by the U.S. Supreme Court in Fifth Third v. Dudenhoeffer. While the plaintiffs did put forth “alternative actions” plan fiduciaries could have taken to avoid participant losses after the September 2016 disclosure of fraud allegations against Wells Fargo caused its stock price to drop significantly, Schiltz found the plaintiffs did not plead specific facts to make plausible their allegation that, under the circumstances of the case, a prudent fiduciary “could not have concluded” that a later disclosure would result in a smaller loss to the company stock fund than an earlier disclosure.
One notable fact about the second district court ruling is that it clearly states Dudenhoeffer does not apply to a claim of breach of the duty of loyalty. Still, the judge determined the plaintiffs’ allegations were nonetheless insufficient to plausibly plead that the plan sponsor breached its duty of loyalty. Further, the lower court found that, because the plaintiffs failed to plausibly allege that defense breached their fiduciary duties under ERISA, their derivative claims also failed. This ruling led to an immediate appeal, which has now proven unsuccessful.
On appeal, the plaintiffs limited their argument to two proposed alternative actions: public disclosure of the unethical sales practices, and freezing purchases in the Wells Fargo Stock Funds. Because the defense could not have implemented a purchase freeze without also disclosing Wells Fargo’s unethical sales practices, the 8th Circuit focused its analysis on the public-disclosure alternative.
“Most circuit courts to consider an imprudence claim based on inside information post-Dudenhoeffer have rejected the argument that public disclosure of negative information is a plausible alternative, finding that a prudent fiduciary could readily conclude that disclosure would do more harm than good by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund,” the ruling states. “[The plaintiffs] argue that the present case is distinguishable, however, because they allege [the defense] knew or should have known that public disclosure of the fraud was inevitable and that, based on general economic principles, the longer the fraud is concealed, the greater the harm to the company’s reputation and stock price.”
At this point, the ruling points to a different case in the 5th U.S. Circuit Court of Appeals.
“In rejecting this argument, the 5th Circuit reasoned that if such a principle were as widely known and generally applicable as the plaintiff suggested, then it would apply in virtually every fraud case,” the ruling states. “But, the court explained, such a principle cannot apply in virtually every fraud case because, in Whitley, the 5th Circuit had already found that a prudent fiduciary could easily conclude that taking an action that might expose fraudulent conduct would do more harm than good. Accordingly, the court found that the plaintiff failed to plausibly allege that a prudent fiduciary in the defendants’ position could not conclude that earlier disclosure of negative information would do more harm than good to the fund.”
The ruling continues: “Turning to the present case, we find that [plaintiffs] have failed to plausibly allege that a prudent fiduciary in [defendants’] position could not have concluded that earlier disclosure would do more harm than good. Like the 5th Circuit in Martone, we find [plaintiffs’] allegation based on general economic principles—that the longer a fraud is concealed, the greater the harm to the company’s reputation and stock price—is too generic to meet the requisite pleading standard.”
The full text of the ruling is available here.