Wells Fargo Wins Stock Drop Suit

Plaintiffs could have told almost from the very first sentence it wasn’t going to go well.

Judge Patrick J. Schiltz described the suit as “…one of many actions in which plaintiffs’ attorneys have taken what is essentially a securities-fraud action and pleaded it as an ERISA action in order to avoid the demanding pleading requirements of the Private Securities Litigation Reform Act of 1995.”

The suit was filed against Wells Fargo & Company by current and former employees of Wells Fargo who held the company’s stock in their 401(k) accounts – stock that suffered significant losses – after Wells Fargo and the U.S. government announced in September 2016 that thousands of Wells Fargo employees had engaged in unethical sales practices, including opening deposit accounts and issuing credit cards without the knowledge or consent of customers.

‘Insider’ Information

Here, as in at least two other suits, plaintiffs allege that the fiduciaries of Wells Fargo’s 401(k) plan were corporate insiders who knew about the improper sales practices long before the public announcement, and failed to fulfill their duty of prudence under ERISA by not disclosing the improper sales practices prior to September 2016. Plaintiffs, of course, argue that if the fiduciaries had disclosed that inside information earlier, the value of the Wells Fargo stock in plaintiffs’ 401(k) accounts would not have dropped as much as it did following the September 2016 announcement.

The court here (In re Wells Fargo Erisa 401(K) Litig., 2017 BL 334045, D. Minn., No. 0:16-cv-03405-PJS-BRT, 9/21/17), as many have before, turned to the decision of the U.S. Supreme Court in the case of Fifth Third Bancorp. v. Dudenhoeffer, 134 S. Ct. 2459 (2014). That was the case where the “presumption of prudence” threshold that had been the law of the land (and resulted in the summary judgement against a large number of plaintiffs in these stock-drop lawsuits) was replaced with a new standard – that, absent “special circumstances affecting the reliability of the market price,” “whether the complaint has plausibly alleged that a prudent fiduciary in the defendant’s position could not have concluded that … 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.”

Judge Schiltz acknowledged that this was “a very tough standard,” going on to note that “trying to predict the impact of anything on the price of a company’s stock – like trying to predict the impact of an athlete’s injury on an upcoming game or the impact of a politician’s gaffe on an upcoming election – is a highly speculative endeavor.” Indeed, he said that an ERISA fiduciary who is trying to figure out whether earlier disclosure of negative inside information would have more or less of an impact on a stock’s price than later disclosure of that negative information is “trying to predict the future on the basis of information that is incomplete, imperfect, and fluid,” and that “in light of the inherently uncertain nature of this task, 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.”

More Harm Than Good?

As for the case at hand, Judge Schiltz said this was not that rare case. “Plaintiffs have not plausibly alleged that defendants could not have concluded that an earlier disclosure of the unethical sales practices would have done more harm than good,” he wrote, dismissing the plaintiffs’ amended complaint.

He noted that plaintiffs argued that there were five alternative actions that the Plan’s fiduciaries could have taken to protect the Plan’s assets:

(1) implemented processes to stop the fraud;

(2) disclosed the fraud to plan participants, the government and the public;

(3) frozen “further stock purchases (and sales)” to “prevent[] Plan Participants from purchasing billions of dollars of Wells Fargo stock at fraudulently-inflated values”;

(4) stopped matching employer contributions in Wells Fargo stock; and

(5) purchased a “hedging product” to offset the anticipated losses that the plan would incur when Wells Fargo’s unethical sales practices came to light.

“The implementation of any of these alternatives would have required disclosure, however,” explained Judge Schiltz. “Obviously, the disclosure alternative would have required disclosure, but the fiduciaries could not have implemented any of the other alternatives without also disclosing the unethical sales practices,” he wrote, and thus, he explained that if the fiduciaries did not violate their duty of prudence when they failed to disclose, they also did not violate their duty of prudence by failing to take the other steps.

And while Judge Schiltz acknowledged that an early disclosure of Wells Fargo’s unethical sales practices would have been consistent with both the letter and the spirit of the securities laws, “the problem for plaintiffs,” he wrote, “is the third Dudenhoeffer requirement – viz., the requirement that they plausibly allege that a prudent fiduciary in the defendant’s position could not have concluded that … 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.” Schiltz noted not only that the “fiduciary’s decision should not be evaluated from the vantage point of hindsight,” but that “a prudent fiduciary may – indeed, must – consider numerous factors in determining whether disclosure would cause a fund more harm than good.” After stepping through an assortment of alternative considerations he said that was “sufficient to make the point that an earlier disclosure is not always better than a later disclosure,” and that “a dozen fiduciaries in the same position could weigh the same factors and reach a dozen different (but equally prudent) conclusions about whether, when, how, and by whom negative inside information should be disclosed.”

“Perhaps for that reason,” Schiltz wrote, “most post-Dudenhoeffer cases have come down on the side of the defendants.” While plaintiffs argued that their case is different because it involves fraud that was ongoing at the time that defendants failed to disclose, Judge Schiltz said that while “ongoing fraud is certainly one factor that a prudent fiduciary might consider in deciding whether early disclosure would better protect the plan’s assets; after all, disclosing the fraud will usually end the fraud, and less fraud will usually mean less damage to the company. But ongoing fraud is not a talisman that will always satisfy Dudenhoeffer’s pleading standard. Rather, it is simply another factor…”

Ultimately, he noted that plaintiffs have failed to plead specific facts to make plausible their allegation that, under the circumstances of this particular case, a prudent fiduciary “could not have concluded” that a later disclosure would result in a smaller loss to the fund than an earlier disclosure.

It wasn’t a complete loss for plaintiffs; Judge Schiltz allowed them to amend their claim of breach of the duty of loyalty, though he said they would have to specify exactly who breached the duty, when, and how.

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