Wells Fargo Fends Off Second Shot at Stock Drop Suit

Having lost on claims of violating their fiduciary duty of prudence in failing to disclose sales practices that led to a drop in stock value in the firm’s 401(k) plan, plaintiffs got another shot regarding claims that Wells Fargo violated their duty of loyalty to plan participants.

The ruling comes 10 months after the judge in the case tossed one of the investors’ fiduciary breach claims against the bank and allowed them to amend their loyalty claim with more specific allegations.

In the case, In re Wells Fargo ERISA 401(k) Litig. (D. Minn., No. 0:16-cv-03405-PJS-BRT, order granting defendants’ motion to dismiss 7/19/18), plaintiffs alleged that defendants violated two distinct duties under ERISA – the duty of prudence and the duty of loyalty – by failing to disclose Wells Fargo’s unethical sales practices prior to September 2016. According to plaintiffs, if defendants had disclosed this information earlier, the value of the Wells Fargo stock in their 401(k) accounts would not have dropped as much as it did.

Previous Case

Judge Patrick J. Schiltz of the U.S. District Court for the District of Minnesota noted that the Wells Fargo defendants had previously – and successfully – argued that plaintiffs’ prudence claim should be dismissed because plaintiffs had not plausibly alleged – as per the standard outlined by the U.S. Supreme Court in Fifth Third Bancorp v. Dudenhoeffer —“that a prudent fiduciary in the defendant’s position could not have concluded that [earlier disclosure of Wells Fargo’s sales practices] … would do more harm than good to the fund…”

They did so, and the Wells Fargo defendants have moved to dismiss that complaint, arguing argue that the Dudenhoeffer pleading standard should be applied “not only to prudence claims, but to loyalty claims – and that, under that standard, plaintiffs’ loyalty claim should be dismissed for the same reasons that their prudence claim was dismissed.”


Judge Schiltz began by explaining that “to fully understand defendants’ argument – and why the Court ultimately rejects it – some background is necessary,” proceeding to note that, “prior to 1995, the federal courts were burdened with a substantial number of abusive securities‐fraud actions,” and that “the filing of a securities‐fraud action seemed to follow on the heels of every substantial drop in the price of the stock of a publicly traded company,” leading Congress to conclude that “nuisance filings, targeting of deep‐pocket defendants, vexatious discovery requests, and ‘manipulation by class action lawyers of the clients whom they purportedly represent’ had become rampant.”

That, in turn, led to the passage of the Private Securities Litigation Reform Act of 1995 (PSLRA), which included the imposition of heightened pleading standards on certain securities fraud actions. Or did, according to Judge Schiltz, until in the wake of the enactment of the PSLRA, “the plaintiffs’ bar came up with a strategy to evade the heightened pleading standards” – a strategy that involved “tak[ing] what is essentially a securities‐fraud action and plead[ing] it as an ERISA action.”

Schiltz noted that, “Plaintiffs’ attorneys are able to evade the PSLRA in this manner – as well as take advantage of the strict duties imposed on fiduciaries by ERISA – by suing not on behalf of those who purchased the stock of a company as members of the investing public, but instead on behalf of those who purchased the stock of a company as participants in a defined‐contribution plan sponsored by that company.”

Legal Standards

From there, Schiltz outlined the “presumption of prudence” standard that had held for a time, and the subsequent replacement of that standard in the Fifth Third case, highlighting specifically that the complaint “plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that stopping purchases – which the market might take as a sign that insider fiduciaries viewed the employer’s stock as a bad investment – or publicly disclosing negative information 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.”

With regard to that standard, Judge Schiltz noted that in its earlier dismissal, this court had characterized this more‐harm‐than-good standard as “very tough” and explained why “plaintiffs will only rarely be able to plausibly allege that a prudent fiduciary ‘could not’ have concluded that a later disclosure of negative inside information would have less of an impact on the stock’s price than an earlier disclosure” – and determined that the earlier pleading did not pass muster based on that standard.

Loyalty Claim

As for the loyalty claim, the defendants argue that turning a prudence claim into a loyalty claim “requires nothing more than adding the allegation that, in failing to disclose or otherwise act upon the inside information, the defendant was motivated by a desire to protect his position as a corporate insider.” A point on which Judge Schiltz agreed, noting that – as had been argued in Fifth Third – “these loyalty claims will deter companies from offering ESOP plans unless district courts apply a mechanism for weeding out meritless claims.”

Schiltz determined that “the concerns that Dudenhoeffer expressed about prudence claims apply with equal force to loyalty claims, and therefore … judges must be as concerned about weeding out meritless loyalty claims as they are about weeding out meritless prudence claims.” Moreover, he also determined that the “mechanism for weeding out meritless claims” described in Dudenhoeffer – a rigorous application of the Iqbal/Twombly plausibility standard – should be applied to both loyalty and prudence claims.”

In short, Judge Schiltz noted that the plaintiffs alleged that defendants acted disloyally by failing to avoid conflicts of interest, by failing to disclose inside corporate information to plan participants, and (perhaps) by affirmatively misleading the general public” – arguments that, Judge Schiltz determined, were “insufficient to make plausible the claim that defendants breached their duty of loyalty under ERISA” – and he dismissed the claim.

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