Participant Files Third Wells Fargo Stock Drop Suit

Another participant is suing Wells Fargo and its executives after losing money on company stock following revelations involving unethical sales practices within the organization’s consumer/retail banking divisions.

Like the previous complaints, this one seeks class action status under the Employee Retirement Income Security Act (ERISA) and alleges that the executives within Wells Fargo who oversee the company’s retirement plan—and its offering of Wells Fargo stock to employees as an investment option—knew about the sales process failures well in advance of the public disclosures. Thus, according to the reasoning in the complaint, they should have dropped the company stock as an imprudent investment option—knowing the illegal sales processes would eventually and necessarily be disclosed and thereby correct the inflated stock price.

The text of the complaint lays out by-now familiar allegations that 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 market value compared with this time last year. The company faces separate civil penalties approaching $200 million—with additional fines likely on the way.

“Based on their knowledge, defendants were duty-bound by ERISA to prevent harm to the plan and its participants from undisclosed and/or false material information that they knew or should have known had made Wells Fargo stock and the stock fund an imprudent investment for retirement purposes,” plaintiffs suggest. “They knew or should have known that the plan was harmed with every purchase made of the stock fund at inflated prices, and that the plan’s large holdings of Wells Fargo stock were at risk for a sizeable downward price correction when the truth finally and inevitably emerged.”

The complaint suggests defendants could have halted new contributions or investments into the Wells Fargo Stock Fund without running afoul of insider-trading restrictions. As in the first two stock-drop lawsuits filed, this will be a critical point in any trial deliberations.

“The act of preventing any new purchases of the Wells Fargo Stock Fund is not illegal insider trading under the federal securities laws because no transaction would occur and no insider benefit would be received by anyone,” plaintiffs argue. “Defendants would simply have to ensure that neither purchases nor sales of the Wells Fargo Stock Fund would be permitted during the time that the freeze was in place. However, taking this action would have prevented serious harm to the plan by at least preventing additional purchases of stock fund shares at inflated prices.”

NEXT: Additional insider trading arguments  

“Defendants could also have tried to effectuate, through personnel with disclosure responsibilities, or, failing that, through their own agency, truthful or corrective disclosures to cure the fraud and make Wells Fargo stock a prudent investment again,” plaintiffs argue. “Defendants also could have directed the plan to divert a portion of its holdings into a low-cost hedging product that would at least serve as a buffer to offset some of the damage the company’s fraud would inevitably cause once the truth came to light … Defendants could not reasonably have believed that taking any of these actions would do more harm than good to the plan or to plan participants.”

Plaintiffs conclude that the longer fraud at a public company like Wells Fargo persists, the harsher the correction is likely to be when that fraud is finally revealed.

“Economists have known for years that when a public company like Wells Fargo prolongs a fraud, the price correction when the truth emerges is that much harsher, because not only does the price have to be reduced by the amount of artificial inflation, but it is reduced by the damage to the company’s overall reputation for trustworthiness as well,” the complaint says. “Some experts estimate that reputational damage can account for as much as 60% of the price drop that occurs when a fraud is revealed. This figure, moreover, increases over time. So, the earlier a fraud is corrected, the less reputational damage a company is likely to suffer ... Such a consideration should have been in the forefront of defendants’ minds once they knew (or should have known) that Wells Fargo’s stock price was artificially inflated by fraud.”

In fact, the complaint goes on to argue that the issuance of corrective disclosures was required by the federal securities laws, not prohibited.

“By the very same mechanism that Wells Fargo could have used to make corrective disclosures to the general public under the federal securities laws, it could also have made disclosures to Plan participants, because Plan participants are, after all, part of the general public,” plaintiffs suggest. “Defendants did not have to make a special disclosure only to plan participants, but could simply have sought to have one corrective disclosure made to the world and thereby simultaneously satisfied the obligations of the federal securities laws and ERISA.”

The full text of the complaint is here.