Stock Drop Suit Targets Wells Fargo

A new lawsuit filed in the U. S. District Court for the District of Minnesota points to Wells Fargo’s ongoing troubles involving unethical sales practices to make the case that 401(k) plan fiduciaries should have dropped company stock as an investment option to protect the best interest of plan participants.

The allegations in the suit follow the classic pattern of so-called “stock drop” litigation, but the new complaint also stands out as unique because of the rapid pace with which it was filed following the triggering disclosure. Followers of the financial services industry will already be aware of the negative media reports and Congressional inquiries that have plagued Wells Fargo’s personal banking wing for roughly a month now. According to published 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 market value compared with this time last year. The company faces separate civil penalties approaching $200 million.

In the new Employee Retirement Income Security Act (ERISA) lawsuit, plaintiffs allege that plan fiduciaries knew well in advance about the problematic sales practices.

“Defendants intentionally withheld material non-public information from plan participants invested in Wells Fargo stock and the public at large about 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,” plaintiffs suggest. “This criminal epidemic was created by Wells Fargo’s senior executives, including its CEO and Chairman, through an incentive structure that encouraged and caused employees to sign up customers for unauthorized and unwanted accounts and other banking products to generate inflated share price growth.”

At the same time, according to the complaint, these 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.

“As a result of this, as well as other conflicts of interest and fraud, defendants violated their fiduciary duties to the plan participants in violation of ERISA, causing no less than hundreds of millions of dollars in damages to the plan,” plaintiffs allege.

NEXT: Examining the plaintiff’s claims 

The claims in the lawsuit are frank: “Since approximately 2010, Wells Fargo, through its management and thousands of its employees, has engaged in a vast, illegal scheme of secretly signing up customers for unauthorized and unwanted accounts and other banking products to generate record, albeit fabricated, share price growth … Setting unreasonably high sales quotas and threatening employees with termination if they failed to meet these quotas, Wells Fargo management encouraged, condoned and profited from thousands of its employees opening over two million unauthorized accounts.

“Wells Fargo senior management, as well as its board of directors, knew about the significant weaknesses in the company’s internal controls and the misconduct at Wells Fargo’s branch level,” the complaint continues, “but consciously and knowingly allowed this systemic problem to continue so that Wells Fargo’s cross-selling statistics—a key metric and the primary reason for the meteoric rise of Wells Fargo stock—remained strong.”

The whole scheme was made public on September 8, 2016, when two federal agencies and the Los Angeles City Attorney announced the findings of an investigation and assessed penalties against Wells Fargo totaling $185 million. The Consumer Financial Protection Bureau (the CFPB) issued a consent order requiring Wells Fargo to pay a $100 million penalty—the highest penalty ever assessed by the regulator—and to take other remedial action. Additionally, the Office of the Comptroller of the Currency  issued a consent order for the assessment of a civil penalty in the amount of $35 million and a cease and desist order, for, among other things, unsafe or unsound practices in Wells Fargo’s risk management and oversight of its sales practices. And, the City and County of Los Angeles settled their lawsuit against Wells Fargo on behalf of California, imposing a $50 million penalty.

According to plaintiffs, the reaction of Wells Fargo management was to announce, for the first time, that over the past few years, 5,300 employees had been fired for this misconduct.

“Wells Fargo, however, failed to mention that internal whistleblowers over the years were railroaded, silenced, and eventually fired. It is still unknown what other systemic problems Wells Fargo is concealing,” they suggest.

NEXT: Were alternative actions possible? 

Plaintiffs use this unsettling information to suggest that, during the proposed class period reaching back to the start of 2014, it “was imprudent and disloyal for defendants to permit the 401(k) to offer funds primarily invested in Wells Fargo stock as investment options, particularly when portions of plan assets automatically defaulted into Wells Fargo stock; permit the plan to invest in funds that are primarily invested in Wells Fargo stock; and permit the plan funds to invest in, and remain invested in, Wells Fargo stock, because it was reasonably foreseeable that the broad and systemic fraud, and the cover-up, would, among other things, adversely affect the company’s stock price.”

Plaintiffs further suggest defendants allowed the imprudent and disloyal investment of the plan’s assets in funds invested in Wells Fargo stock throughout the class period “despite the fact that defendants possessed non-public, material information bearing adversely on the plan’s continued investment in Wells Fargo stock.”

“Defendants knew that Wells Fargo was perpetrating a broad and systemic fraud scheme in its Banking and Retail divisions,” plaintiffs conclude.

It is obviously too soon to predict the future of the potential class action litigation, but similar cases have turned on the ease or difficulty of proving there was another course of action a prudent and knowledgeable fiduciary would have taken to get rid of the stock as an investment option without running afoul of insider trading restrictions on public stock. In fact, the complaint seems to focus much more on detailing the wrongdoings of Wells Fargo’s retail banking arm. Only near the end of the complaint do plaintiffs engage with the argument that a prudent fiduciary would/should not have concluded any number of alternative actions other than simply holding the stock and continuing to offer it as an investment option would have done more harm than good, ultimately, for plan participants.

Here’s how plaintiff’s make the effort: “Defendants failed to conduct an appropriate investigation into whether Wells Fargo stock was a prudent investment for the plan. An adequate (or even cursory) investigation by defendants would have revealed to a reasonable fiduciary that investment by the plan in Wells Fargo stock was clearly imprudent, as well as disloyal. A prudent and loyal fiduciary acting under similar circumstances would have determined that Wells Fargo stock was not a prudent and loyal investment and acted to protect participants against unnecessary losses, and would have made different investment decisions.

“Any tension between securities law and a defendants’ fiduciary obligations is one of its own making,” plaintiffs conclude. “Fiduciaries without disclosure obligations under the federal securities laws, as well as those with such obligations, have it within their power to prevent harmful investments by plan participants. Fiduciaries without disclosure obligations should act to protect plan participants as soon as they know or should know that material information for which disclosure is required under securities laws is not being released to the public. Fiduciaries without securities law disclosure obligations should act to protect the plan participants under ERISA as soon as the federal securities laws require disclosure. The fact that certain fiduciary defendants decided not to act at an early stage does not mean that ERISA fiduciary duties do not apply thereafter. Rather, it means quite the opposite. It means that they are continuing to violate their fiduciary duties by not acting.”

According to the plaintiffs, “defendants had available to them several different alternative options for satisfying their duty of prudence, including, among other things: temporarily removing the funds primarily invested in Wells Fargo stock as an investment option in the plan; discontinuing or freezing further contributions to and/or investment in Wells Fargo stock under the plan; consulting independent fiduciaries regarding appropriate measures to take in order to prudently and loyally serve the participants of the plan; initiating investigations and corrective actions to eliminate the conflicts of interest, eliminating the company’s widespread fraudulent activities and concealment, and changing the policies and incentive structures underlying such activities; and/or resigning as fiduciaries of the plan to the extent that as a result of their employment by Wells Fargo they could not loyally serve the plan and its participants in connection with the plan’s acquisition and holding of Wells Fargo stock.”

The complaint in Allen v. Wells Fargo & Company is here.