Compliance October 25, 2016

Third Wells Fargo ERISA Stock Drop Complaint Filed

Wells Fargo faces a third ERISA stock drop lawsuit in the U. S. District Court for the District of Minnesota.
Reported by

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.

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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. 

Client Service October 25, 2016

Efforts Needed to Reduce DC Plan Cashouts

Cashouts are the biggest portion of defined contribution retirement plan leakage, but what can be done?
Reported by

Addressing the issue of defined contribution (DC) retirement plan leakage has been a task on which players in the retirement industry have been working for years.

There are already strict requirements for when a DC plan participant can take a hardship withdrawal. It has been recommended that DC plan sponsors limit the number of loans participants can take or limit the accounts from which they can take loans. It has also been noted that there is nothing in the law that says participants must pay loans in full upon termination of employment, but the problem with allowing ex-participants to continue to make repayments may be with the recordkeeper. 

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However, hardship withdrawals and participant loans are not the biggest leakage problem DC plans have. “Without a doubt, cashouts are biggest portion of retirement plan leakage,” says Employee Benefit Research Institute (EBRI) Research Director Jack VanDerhei, based in Washington, D.C. An analysis conducted by VanDerhei for EBRI in 2014 found approximately two-thirds of the leakage impact is associated with cashouts that sometimes occur at job change.

A demonstration provided by Retirement Clearinghouse shows that in just more than 30 years, total cashouts could reach $282 billion, and rollovers to other qualified plans would be only $14.7 billion among 8.4 million participants. Its analysis did not include appreciation, so these amounts would be larger if average returns were included. Retirement Clearinghouse has introduced an innovation that it hopes could change these numbers.

NEXT: Introducing auto-portability

Currently, under the Employee Retirement Income Security Act (ERISA), DC plan sponsors are allowed to automatically force out participant account balances less than $5,000. For amounts between $1,000 and $5,000, the amounts must be placed in a safe harbor individual retirement account (IRA).

Spencer Williams, president and CEO of Retirement Clearinghouse, explains that its automatic portability solution would use the demographic data from that rollover, send it to recordkeepers to see if there is a match in their system and if one is found, automatically rollover the employee’s IRA account to his new plan.

Retirement Clearinghouse’s demonstration shows that in just more than 30 years, under auto-portability, cashouts would be reduced to $144.3 billion, and rollovers would be $133.5 billion among 77.5 million participants.

VanDerhei says until there is legislation to address cashouts, automatic roll-ins are the best way of trying to do something that will use employees’ inertia for their own good. “If we can link those relatively small amounts from the past employer to the future employer, we’ve seen over and over the size of the account balance increases,” he tells PLANADVISER. “And if we can get employees’ balances up to a sweet spot for a particular age, they will see their balances as significant enough to not take out of the plan.” Williams says that sweet spot starts at $10,000 and goes up to $20,000.

“The probability of cashing out drops from 90% to 30% when a participant’s account goes over $20,000,” Williams tells PLANADVISER. He notes that auto-portability can help participant accounts get to $20,000 much sooner, and it also makes rollovers easier for participants.”

NEXT: Regulations, legislation and employee education

VanDerhei says he has no knowledge of anyone trying to address the cashout problem legislatively. This past summer, the Bipartisan Policy Center’s Commission on Retirement Security and Personal Savings issued a report recommending that to prevent leakage from retirement plans, policymakers must ease the process for transferring savings from plan to plan. But, VanDerhei says just because the Bipartisan Policy Center made proposals for addressing the DC retirement system’s problems doesn’t mean anyone will try to issue a legislative package for all or any of its suggestions.

The Internal Revenue Service (IRS), however, has made attempts to make the plan-to-plan rollover process easier: by introducing an easy way for a receiving plan to confirm the sending plan’s tax-qualified status; issuing new guidance for allocating pre-tax and after-tax amounts among distributions that are made to multiple destinations from a qualified plan; and introducing a new self-certification procedure designed to help recipients of retirement plan distributions who inadvertently miss the 60-day time limit for properly rolling these amounts into another retirement plan.

VanDerhei says employees do get frustrated with what they have to do to rollover their assets to a new plan, so making that easier is key.

However, he also notes that with the new financial wellness interest among employers, information directed at a DC plan participant at the point of termination of employment could have an impact. “If they realize what [cashing out] will cost them in the long run and how it will affect their total retirement savings, it could modify the behavior of some participants,” VanDerhei says. He adds, however, that there are some people, no matter what the plan sponsor does or says, who need the money and will cash out.

“In any case, automatic provisions trump anything plan sponsors can do with education,” VanDerhei concludes. “It will still allow employees access to their cash if they need it, but the default will be best for them in the long run.

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