Yet another stock drop participant-plaintiff has come up short—this time on appeal.
The original suit dates back to 2016. Echoing themes common to these so-called “stock drop” suits, the Wells Fargo defendants were charged with intentionally withholding “material non-public information” from plan participants invested in Wells Fargo stock.
Here those plaintiffs had cited “a criminal epidemic at Wells Fargo associated with a critical component of Wells Fargo’s business model and key driver of its stock price—i.e., cross-selling.” This while the suit alleges that “senior executives sold millions of their personal Wells Fargo stock at inflated prices, earning hundreds of millions of dollars, while failing to take corrective action to protect Plan Participants.” According to the original complaint, Wells Fargo's stock price nearly doubled during the six-year period of increased cross-selling—which the suit claims served to artificially inflate the stock price—before dropping in value once news of the cross-selling plan broke.
District Determinations
The district court granted Wells Fargo’s motion to dismiss the first amended complaint, finding that the allegations made failed to meet the criteria required by the U.S. Supreme Court in Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014), in that they “failed to plausibly allege that a prudent fiduciary in Appellees’ position could not have concluded that Appellants’ proposed alternative actions would do more harm than good to the Wells Fargo Stock Funds.” Thus, the court dismissed that claim with prejudice, and also found that Appellants had not pled a “freestanding claim of breach of the duty of loyalty” and also dismissed that claim, but without prejudice (allowing for another shot).
Well, the plaintiffs (now appellants) then filed a second amended complaint, alleging that Wells Fargo breached their duty of loyalty by “failing to disclose the unethical sales practices, freeze investment in the Wells Fargo Stock Funds, or avoid conflicts of interest.” The Wells Fargo defendants/appellees also sought dismissal, once again invoking the Dudenhoeffer standards, but while the district court rejected the application of those standards to a breach of loyalty, they found that the allegations were “nonetheless insufficient to plausibly plead that Appellees breached their duty of loyalty,” and found that, because they failed to “plausibly allege that Appellees breached their fiduciary duties under ERISA, their derivative claims also fail.”
Leading to the current appeal.
Appellate Review
The U.S. Court of Appeals for the Eighth Circuit’s review of the motion to dismiss for failure to state a claim (Allen v. Wells Fargo & Co., 8th Cir., No. 18-2781, 7/27/20) was premised upon “assuming all factual allegations as true and construing all reasonable inferences in the light most favorable to Appellants, the nonmoving party.”
Consider those issues, Judge Bobby E. Shepherd (joined in the decision by Judges L. Steven Grasz and Jonathan A. Kobes) cited three considerations. First, “in deciding whether a complaint states a claim, courts must bear in mind that ERISA’s duty of prudence cannot require the ESOP fiduciary to perform an action that would violate securities laws.” Second, “courts should consider the extent to which an ERISA-based obligation ... could conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of those laws.” And third, whether “the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that [the alternative action] ... would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.” The last factor, the court notes, requires a fact-based inquiry that “focuses on the information available to the fiduciary at the time of the relevant investment decision.”
Alternative Actions
The plaintiffs/appellants limited their argument to two proposed alternative actions: public disclosure of the unethical sales practices and freezing purchases in the Wells Fargo Stock Funds, and (noting that Wells could not have implemented a purchase freeze without also disclosing the practices), the court focused on the public-disclosure alternative.
The court starts by noting that “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.” Not surprisingly, the appellants here argue that this case is different, “because they allege Appellees 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.” The court considered several cases that it considered to have presented similar arguments, but found no support for the plaintiff/appellant argument.
‘Plausible’ Denials
The one instance the court found where a plaintiff plausibly alleged that a prudent fiduciary in the defendant’s position could not conclude that earlier disclosure of fraud would do more harm than good is the recent case in the Second Circuit of Jander v. Retirement Plans Committee of IBM. Indeed in Jander, this court noted that it was determined that when the stock drop is inevitable, “it is far more plausible that a prudent fiduciary would prefer to limit the effects of the stock’s artificial inflation on the ESOP’s beneficiaries through prompt disclosure.”
That said, in considering the current case, this court again concluded that the appellants “failed to plausibly allege that a prudent fiduciary in Appellees’ position could not have concluded that earlier disclosure would do more harm than good.” The judges ruled that the 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—sided with the analysis in Martone v. Robb finding that it was “too generic to meet the requisite pleading standard.”
Even when considering those principles “as part of the overall picture” as the Jander court did, this court came to the same conclusion. “We find particularly important Appellants’ allegation that Appellees knew that government regulators were conducting an investigation into Wells Fargo’s sales practices since at least 2013 and up until the disclosure in 2016,” they write. “We find that a prudent fiduciary—even one who knows disclosure is inevitable and that earlier disclosure may ameliorate some harm to the company’s stock price and reputation—could readily conclude that it would do more harm than good to disclose information about Wells Fargo’s sales practices prior to the completion of the government’s investigation.
“Accordingly, we find that the district court did not err in finding that Appellants have failed to plausibly plead that a prudent fiduciary could not have concluded that Appellants’ proposed alternative actions would do more harm than good,” the decision concludes.
Loyalty Lessons
As for that duty of loyalty, the appellate court rejected comparisons of cases involving the disclosure of plan information, rather than non-public information about the company, and went on to cite decisions in other circuits that the duty of loyalty does not require disclosure of non-public information about the company that might impact the plan participants. They wrote, “As the Eleventh Circuit explained, there is good reason for the distinction between plan information and non-public information that may affect stock value: if there were an affirmative duty to disclose non-public information that would impact the stock, such a duty “would improperly transform fiduciaries into investment advisors.” Indeed, Judge Shepherd notes that “such an affirmative duty would circumvent the Dudenhoeffer standard and render it worthless; there would be no reason to analyze whether a prudent fiduciary could have concluded that disclosure of non-public information would do more harm than good.”
Judge Shepherd dispensed with an alternative argument—that the Wells Fargo defendants “chose not to disclose the unethical sales practices so as to not jeopardize their own high-ranking positions” nearly as abruptly. He commented that, “beyond this conclusory allegation, Appellants fail to allege any specific facts from which a court can infer that Appellees were motivated by disloyal reasons in choosing not to disclose information.” He also determined that sales by those Wells Fargo defendants at the “inflated” prices “…without more, is insufficient to give rise to a plausible inference that Appellees breached their duty of loyalty.”
Instead, he was “persuaded by Appellees’ argument that Appellants’ disloyalty claim 'merely recasts the imprudence claim' so as to circumvent the demanding Dudenhoeffer standard,” going on to find that “the district court did not err in holding that appellants have failed to sufficiently plead a claim of breach of the duty of loyalty,” and that “because the district court properly dismissed Appellants’ claims of breach of fiduciary duties, the district court also properly dismissed Appellants’ derivative claims of co-fiduciary liability and breach of the duty to monitor.”
What This Means
In the wake of every earnings surprise and corporate misconduct there has come a series of these “stock drop” cases. And yet, despite their number, the diversity of venues in which the suits have been filed, and a standard of proof arguably modified to make such claims easier to prove—plaintiffs have repeatedly come up short.
In 2014 the Supreme Court seemed truly concerned that the “presumption of prudence” standard basically established a standard that was effectively unassailable by plaintiffs—and in fact, until that point the vast majority of these cases (including BP and Delta Air Lines, Lehman and GM) failed to get past the summary judgment phase. Indeed, the plaintiff in the IBM case had argued that no duty-of-prudence claim against an ESOP fiduciary has passed the motion-to-dismiss stage since the 2010 decision in Harris v. Amgen. They had also noted that “imposing such a heavy burden at the motion-to-dismiss stage runs contrary to the Supreme Court’s stated desire in Fifth Third to lower the barrier set by the presumption of prudence.”
However, when the “more harm than good” standard emerged with Fifth Third Bancorp v. Dudenhoeffer, it didn’t just establish a new standard; it also led to a refiling of claims of many of the so-called “stock drop” suits. Ironically, up until the IBM decision, those too had generally come up short of the new standard—though they did at least get past the summary judgment stage.
However, even the relitigations haven’t fared well—and you can now add the decision here to that slate. As the 11th Circuit noted in a case involving Delta Air Lines, “while Fifth Third may have changed the legal analysis of our prior decision, it does not alter the outcome.”
