The U.S. District Court for the District of Minnesota has ruled once again on a complicated stock drop lawsuit filed by participants in Wells Fargo’s retirement program, related to the firm’s difficulties in recent years with problematic sales practices in the personal banking side of its business.

The allegations in the suit follow the classic pattern of so-called “stock drop” litigation. By way of background, negative media reports and Congressional inquiries have plagued Wells Fargo’s personal banking wing for several years now, starting in late summer 2016. According to contemporaneous 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. The company faced separate civil penalties approaching $200 million.

Ruling on the first version of the complaint, which was consolidated with a second lawsuit filed by another set of Wells Fargo employees in the same venue, U.S. District Judge Patrick J. Schiltz disagreed that Wells Fargo fiduciaries violated their duties of prudence and loyalty under the Employee Retirement Income Security Act (ERISA) by keeping company stock as an investment in its 401(k) plan when, plaintiffs alleged, plan fiduciaries knew the stock price was inflated.

In that first decision and now in a second ruling, Schiltz relied on the pleading standards set forth by the U.S. Supreme Court in Fifth Third v. Dudenhoeffer. While the plaintiffs did put forth alternative actions plan fiduciaries could have taken to avoid participant losses after the September 2016 disclosure of fraud allegations against Wells Fargo caused its stock price to drop significantly, Schiltz found the plaintiffs did not plead specific facts to make plausible their allegation that, under the circumstances of the case, a prudent fiduciary “could not have concluded” that a later disclosure would result in a smaller loss to the company stock fund than an earlier disclosure. Also at issue in the judge’s rulings for defendants was that the complaints did not clearly separate the prudence claim from the loyalty claim. 

Schiltz left room, however, for plaintiffs to take a final crack at defining their standing to sue for breaches of the duties of prudence and loyalty, leading to this second decision. In a phrase, participants have again flatly failed to jump the tall hurdles set out by Dudenhoeffer.

The text of the decision is interesting in that the defendants also put forward arguments that failed. In particular, the Wells Fargo defendants argued that the Dudenhoeffer pleading standard should be applied not only to prudence claims, but to loyalty claims as well—and that, under that standard, plaintiffs’ loyalty claim should be dismissed for the same reasons that their prudence claim was dismissed. After some detailed consideration by Schiltz that covers the history of stock drop and stock fraud litigation going back as far as 1995 and the passage of the Private Securities Litigation Reform Act of 1995, this argument is rejected (although defendants succeed on other grounds).

Here is how Schiltz explains the court’s thinking: “Defendants concede that Dudenhoeffer was explicitly limited to prudence claims. But, say defendants, just about any prudence claim can easily be recast as a loyalty claim. That is particularly true in insider‐information cases. By definition, these are cases in which the defendant was a corporate insider who served as the fiduciary of an [employee stock ownership plan] plan, the defendant received negative inside information about the company, and the plaintiff alleges that the defendant breached the duty of prudence by not disclosing or otherwise acting upon that inside information. In that context, defendants argue, turning a prudence claim into a loyalty claim requires nothing more than adding the allegation that, in failing to disclose or otherwise act upon the inside information, the defendant was motivated by a desire to protect his position as a corporate insider.”

To this point, the court agrees with defendants, and it also agrees with defendants that—given how easy it is for a plaintiff to convert a prudence claim into a loyalty claim in an insider‐information case—the Supreme Court would have as much concern about these loyalty claims as it had about the prudence claims in Dudenhoeffer. But this is where the argument falters, as follows: “The problem with defendants’ argument is that it wrenches the more‐harm‐than‐good standard out of context. The Supreme Court was very clear in Dudenhoeffer about how district courts should weed out meritless prudence claims—by rigorously applying the Iqbal/Twombly plausibility standard. And this Court is confident that, if faced with the question, the Supreme Court would hold that district courts should weed out meritless loyalty claims in the same way—by rigorously applying the Iqbal/Twombly plausibility standard. But a judge who is applying the Iqbal/Twombly standard to a loyalty claim must necessarily ask different questions than a judge who is applying the Iqbal/Twombly standard to a prudence claim, for the simple reason that the elements of the two claims are not the same.”

The decision further clarifies that the duty of prudence requires fiduciaries to act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” This is an objective standard, the decision states, and so the subjective intentions of the fiduciary are irrelevant. “By contrast,” the decision continues, “the duty of loyalty requires fiduciaries to act for the exclusive purpose of providing benefits to participants and their beneficiaries.” This is a subjective standard, and what matters is why the defendant acted as he did.

“Thus, a plaintiff who brings a loyalty claim does not have to plead or prove anything about what a hypothetical prudent person would have done under the same circumstances,” the decision concludes. “Instead, the plaintiff must plead and prove that the defendant acted to further his own interests rather than the interests of the fund.”

Hence, when defendants demand that the court here apply the more‐harm‐than‐good standard to plaintiffs’ loyalty claim, defendants are demanding that plaintiffs be required to plead something that they are not required to prove. The law imposes no such requirement, the decision concludes.

Moving on and applying the Iqbal/Twombly standard to plaintiffs’ loyalty claim, the court still finds that the claim is not plausible, and thus the court dismisses it. Important to this part of the decision, the judge explains, is the fact that ERISA does not prohibit corporate officers (who hold substantial amounts of company stock) from also serving as fiduciaries of ESOPs. On the contrary, “persons who serve as fiduciaries may also act in other capacities, even capacities that conflict with the individual’s fiduciary duties.”

“What ERISA requires is that the fiduciary with two hats wear only one hat at a time, and wear the fiduciary hat when making fiduciary decisions,” the decision concludes. “Defendants have no duty under ERISA to disclose [negative inside] information; any such duty would arise under the securities laws, and, if defendants have acted wrongly, they can be held accountable under those laws. Therefore, to the extent that plaintiffs’ loyalty claim relies solely on defendants’ non-disclosure of inside information about Wells Fargo’s present and future financial condition, plaintiffs’ loyalty claim must be dismissed.”

The full text of the second decision is available here.