The United States District Court for the Northern District of California recently denied the motion of Wells Fargo & Company (“Wells Fargo”) to dismiss claims that its directors and officers breached their fiduciary duties to shareholders during the mortgage crisis. Judge Susan Illston ruled that the plaintiffs, Wells Fargo shareholders suing derivatively on behalf of Wells Fargo, had pled particularized facts alleging that defendants breached their duty of loyalty by allegedly omitting material facts about the company’s practices in the proxy statement to shareholders. Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust v. Stumpf, No. C 11-2369 SI (N.D. Cal. 2012).

Background

In May 2011, shareholders of Wells Fargo instituted a derivative action against the company’s board of directors, alleging claims for breach of fiduciary duty, abuse of control, gross mismanagement and corporate waste, arising from the company’s policy of mass processing or “robo-signing” the declarations or affidavits to be submitted in Wells Fargo’s foreclosure proceedings. The plaintiffs alleged that the practice recklessly avoided the actual work and costs associated with obtaining facts or documents representing ownership, standing and the right to foreclose on properties. They also alleged that the policy concealed the possibility that title and standing might not be perfected, and therefore required Wells Fargo employees to file false affidavits on behalf of the company.

Plaintiffs’ allegations were supported by testimony from two Wells Fargo employees in which they admitted to signing unverified affidavits, as well as news articles that documented the bank’s robo-signing practice. Additionally, in October 2010, defendant Howard Atkins, Wells Fargo’s former Chief Financial Officer and Executive Vice President, had stated that the robo-signing policy was designed by Wells Fargo and the policy was sound and accurate. One week later, Wells Fargo issued a press release admitting that its foreclosure processes did not adhere to the company’s formal policy, and that it was reviewing more than 55,000 foreclosure affidavits.

The complaint also alleged that Wells Fargo’s board of directors urged its shareholders to reject a proposal calling for the Audit Committee to conduct an independent review of the company’s internal controls related to foreclosures, claiming in its proxy statement that it had already undertaken comprehensive self assessments and reviews of its mortgage servicing processes, and was cooperating with reviews undertaken by federal banking regulators. According to the allegations, Wells Fargo in fact had been filing motions to quash discovery and appeals in order to stall government investigations, and had continued robo-signing, even after stating that the practice had been stopped more than six months earlier.

Government Settlement

In addition to the shareholder derivative action, Wells Fargo faced allegations of misconduct from federal and state government regulators, arising from the same practices. In February 2012, the company entered a settlement agreement with state and federal governments, releasing it from claims regarding its handling of foreclosures and requests for loan modifications, including the use of robo-signed affidavits in foreclosure proceedings. In exchange, Wells Fargo agreed to

pay more than $5 billion to borrowers who lost their homes to foreclosure as part of $25 billion government settlement between federal and state governments and Wells Fargo, Bank of America Corp., JP Morgan Chase & Co., Citigroup Inc. and Ally Financial Inc. Though the settlement was based on related allegations, it had no direct impact on the shareholder derivative action against the bank.

Wells Fargo’s Motion to Dismiss

Wells Fargo moved to dismiss the shareholders’ complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). The court noted that, for a shareholder derivative action to survive a motion to dismiss, plaintiffs must adequately allege: (1) that they contemporaneously owned Wells Fargo stock at the time of the wrongful acts and continue to own stock through the suit, (2) that they made a demand to the board of directors for corrective action or that the demand was futile, and (3) adequate and particularized facts to support their claims.  

The court found the plaintiffs had satisfied the contemporaneous ownership and demand futility requirements. It held that a demand for action from Wells Fargo’s directors would have been futile because, based on the allegations against the board, there was a substantial likelihood the directors could be personally liable for the alleged wrongful acts, and there was a reasonable doubt that at least half the directors could have properly exercised their independent and disinterested business judgment in responding to the demand.  

The court also found that particularized facts alleging breach of fiduciary duty had been pled. Judge Illston explained that, if the complaint’s allegations were true, and defendants had in fact claimed in the company’s proxy statement they were cooperating with government investigations when, in fact, they were not, it would amount to a material omission and a breach of the duty of loyalty to the company. The court therefore denied defendants’ motion to dismiss the claim for breach of fiduciary duty.  

The court also granted defendants’ motion to dismiss the shareholders’ claims for abuse of control, gross mismanagement and corporate waste. The court held that Delaware law, which governed these claims because Wells Fargo is a Delaware corporation, does not recognize an independent cause of action against corporate directors and officers for abuse of control or gross mismanagement; such claims are treated as claims for breach of fiduciary duty. It also held that the shareholders had not adequately met their burden to plead corporate waste, because they had not alleged the payment of bonuses to Wells Fargo’s director and former Chief Financial Officer and Executive Vice President after they made false statements to the public served no corporate purpose, and thus no consideration was received.

Conclusion

Judge Illston’s denial of the motion to dismiss the shareholders’ claim for breach of fiduciary duty demonstrates that banks are vulnerable to such suits based upon their conduct during the mortgage crisis, even following the large financial settlement with the government. Similar shareholder actions have also been filed against JP Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.