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From Securities Regulation Daily, February 28, 2018

Wells Fargo class action survives motion to dismiss

By Rebecca Kahn, J.D.

Wells Fargo shareholders’ securities class action alleging fraud, insider trading, and control person liability largely survived a motion to dismiss in California district court. When they filed SEC reports, issued press releases, and held investor conferences touting the company’s cross-selling business model as a financial success, the shareholders claimed that most of the officers and directors knew that those sales never took place. The company also allegedly had secretly opened new deposit and credit card accounts for existing customers without their knowledge or permission (Hefler v. Wells Fargo & Co., February 27, 2018, Tigar, J.).

Lawsuit. This action was brought on behalf of purchasers of Wells Fargo stock between February 26, 2014 and September 20, 2016. The plaintiffs alleged that Wells Fargo employees resorted to committing the sales fraud because of a "toxic, high-pressure sales culture and ill-conceived compensation plan" and ruthless pressure exerted from the top down. The plaintiffs further alleged that Wells Fargo was aware of these practices since 2011, and that its executives and directors had been aware of them since 2013. When the truth came out in September 2016, Wells Fargo stock price plunged.

Numerous lawsuits were filed and some were consolidated into this class action against Wells Fargo for violating Exchange Act Sections 10(b) and Rule 10b-5 thereunder, as well as Sections 20A and 20(a). As in last October’s related derivative litigation order these claims were rooted in quarterly and annual filings between 2011 and 2016 and alleged that director and officer defendants led or participated in committees responsible for monitoring the allegedly fraudulent practices. There, the court found plausible allegations that the defendants made the material and misleading statements by participating in and approving the company’s public filings. They knew that Wells Fargo accounts were being improperly created but, nonetheless, made disclosures in SEC filings that they knew were false or misleading at the time.

In this case, the plaintiffs identified many of these same statements that touted the success of Wells Fargo’s cross-selling metrics and risk management controls. The complaint alleged that the defendants knew or deliberately disregarded that Wells Fargo materially and artificially inflated the cross-sell metrics that it reported to investors by including millions of accounts that Wells Fargo either completely fabricated or created by engaging in sales misconduct. The plaintiffs alleged that because of their positions of control and authority as officers and/or directors, the defendants were able to, and did control, the content of various SEC filings, news releases, and other public statements pertaining to Wells Fargo during the class period.

Scienter. The court previously held that "Just as it is implausible that the Director Defendants were unaware of the account-creation scheme given the extent of the alleged fraud and the number of red flags, it is implausible that Wells Fargo’s senior management, involved in the day-to-day operations of the bank and with greater access to the underlying cross-sell metrics and employee whistleblower complaints than independent board members, was unaware of the alleged fraud." The court concluded that the derivative action plaintiffs established a strong inference of scienter. The complaint in this action mirrors many of the derivative action’s allegations. As such, the court found the complaint adequately alleged facts showing a strong inference of scienter on the part of officers and directors. These allegations were sufficient to raise an inference of scienter as to Wells Fargo, as well.

Loss causation. The defendants argued that the plaintiffs failed to show that their losses were caused by disclosure that any of the alleged misstatements were false. But the court found sufficient allegations of substantial stock price drops after each disclosure: (1) a September 2010 disclosure that Wells Fargo settled with the government and was fined for fraudulent sales practices; (2) a September 2016 news release that Wells Fargo would eliminate the sales goals and incentives that contributed to the fraudulent conduct; (3) DOJ subpoenas to Wells Fargo; and (4) subsequent congressional testimony of the fraudulent conduct. The plaintiff’s allegations that Wells Fargo stock experienced a statistically significant drop after each of these disclosures were sufficient to plead a claim.

Insider trading. The plaintiffs alleged that certain defendants profited by selling Wells Fargo common stock while in possession of adverse, material non-public information about the company. The defendants argued that the Section 20A claims failed for certain defendants because the complaint did not adequately plead any "contemporaneous trades." Some sold stock the trading day before and others sold four and five trading days before the lead plaintiff’s purchase. The court ruled that trading on the same day or the day after is "contemporaneous" and granted the plaintiffs leave to amend the complaint to allege a subclass of contemporaneous traders.

The case is No. 3:16-cv-05479.

Attorneys: Shawn A. Williams (Robbins Geller Rudman & Dowd LLP) for Gary Hefler. Brendan P. Cullen (Sullivan & Cromwell LLP) for Wells Fargo & Co.

Companies: Wells Fargo & Co.

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