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Shaev v. Baker

United States District Court, N.D. California

May 4, 2017

VICTORIA SHAEV, Plaintiff,
v.
JOHN D. BAKER, et al., Defendants.

          ORDER GRANTING IN PART AND DENYING IN PART MOTION TO DISMISS RE: ECF NO. 99

          JON S. TIGAR United States District Judge.

         Before the Court is nominal Defendant Wells Fargo & Company's (“Wells Fargo”) motion to dismiss the Consolidated Amended Verified Amended Stockholder Derivative Complaint (“the Complaint”) pursuant to Rules 12(b)(6) and 23.1 for failure to adequately plead demand futility.[1]The Court will grant the motion as to Plaintiff's claim under California Corporations Code section 25403, and deny it in all other respects.

         I. BACKGROUND

         This is a shareholder derivative action on behalf of nominal party Wells Fargo against the company's officers and directors. Compl. ECF No. 83 at 6, ¶ 64.[2] Plaintiffs allege that, “[f]rom at least January 1, 2011 to the present (‘the Relevant Period'), Defendants knew or consciously disregarded that Wells Fargo employees were illicitly creating millions of deposit and credit card accounts for their customers, without those customers' knowledge or consent.” Id. ¶ 1.

         A. The Parties

         Wells Fargo is a financial and bank holding company that provides retail, commercial, and corporate banking services. Id. ¶ 66. The company is incorporated in Delaware and headquartered in San Francisco, California. Id. Wells Fargo's largest reportable operating segment[3] during the relevant period, the Community Banking division, “focuses on diversified financial products and services to customers and small businesses, including checking and savings accounts, credit and debit cards, as well as auto, student, and small-business lending.” Id. ¶ 69.

         The Lead Plaintiffs are Fire and Police Pension Association of Colorado and the City of Birmingham Retirement and Relief System. Id. ¶¶ 61, 63. Plaintiffs have owned Wells Fargo common stock since at least January 1, 2011 and remain current stockholders of the company. Id. ¶ 1, 65.

         The Individual Defendants were officers and directors of the company during the relevant period. Defendant John G. Stumpf served as Wells Fargo's CEO from June 2007 until his resignation on October 12, 2016. Id. ¶ 70. He was also a director between June 2006 and January 2010, when he became Chairman of the Board. Id. Following Stumpf's resignation in October 2016, Defendant Timothy J. Sloan became Wells Fargo's CEO. Id. ¶ 71. Defendant Carrie Tolstedt served as Senior Executive Vice President of the Community Banking division from June 2007 to July 2016. Id. ¶ 72. The Director Defendants during the relevant time period include: John D. Baker II (director since January 2010); Elaine L. Chao (director from July 2011 to January 2017); John S. Chen (director since September 2006); Lloyd H. Dean (director since June 2005); Elizabeth A. Duke (director since January 2015); Susan E. Engel (director since May 1998); Enrique Hernandez (director since January 2003); Donald M. James (director since January 2009); Cynthia H. Milligan (director since July 1992); Enrique Peña (director since November 2011); James H. Quigley (director since October 2013); Judith M. Runstad (director from May 1998 to April 2016); Stephen W. Sanger (director since 2003); Susan G. Swenson (director since November 1998); Suzanne M. Vautrinot (director since February 2015). ¶¶ 76-91.

         B. Cross-Selling

         Throughout the relevant period, Wells Fargo's financial condition and prospects were dependent upon cross-selling ‒ i.e., the sale of new products and services to existing customers. Id. ¶ 3.

         As explained in Wells Fargo's 2006 Annual Report, “‘[s]elling more products to [its] customers ‒ or “cross-selling” ‒ is the foundation of [its] business model and key to [its] ability to grow revenue and earnings.'” Id. ¶ 126. The 2007 Annual Report further explained that “the Bank's ‘primary strategy to achieve [its] vision' was ‘to increase the number of products our customers buy from us and to give them all of the financial products that fulfill their needs.'” Id. ¶ 127 (brackets added). The same 2007 Report went on to explain that the “cross-sell strategy and diversified business model . . . ‘facilitate growth in strong and weak economic cycles, as we can grow by expanding the number of product out current customers have with us.'” Id. That Report further noted that “Wells Fargo was ‘known across [its] industry as number one, second to none, for cross-sell and revenue growth.'” Id. (emphasis omitted). The 2010 Annual Report similarly touted Wells Fargo as “the king of cross-sell.” Id. ¶ 130. Likewise, the 2013 Annual Report stated that “cross-sell of our products is an important part of our strategy to achieve our vision to satisfy all our customers' financial needs . . . . We believe there is more opportunity for cross-sell as we continue to earn more business from our customers.” Id. ¶ 134 (emphasis omitted). Wells Fargo's 2013 SEC filings explained that cross-selling was critical to the company's financial success:

Our “cross-selling” efforts to increase the number of products our customers buy from us … is a key part of our growth strategy, and our failure to execute this strategy effectively could have a material adverse effect on our revenue growth and financial results. Selling more products to our customers ‒ “cross-selling” ‒ is very important to our business model and key to our ability to grow revenue and earnings… Id. ¶ 135.

         The company tracked and reported yearly cross-sell numbers, and this “was often the first metric announced in the Annual Reports to shareholders.” Id. ¶ 142.

         Cross-selling numbers progressively grew between 1998, “when the products per retail banking household was 3.2, ” and 2010, when that number reached an average of 6.14 products per household. Id. ¶ 142. That number reached its zenith in 2014, at 6.17 products per household. Id. ¶ 144.

         C. Gr-Eight Initiative

         To achieve their cross-selling goals, “Defendants imposed strict quotas regulating the number of products Wells Fargo bankers must sell.” Id. ¶ 2.

         As early as 1999, the bank established the “Great Eight” or “Gr-Eight” initiative, which set a goal of selling eight products per household. Id. ¶¶ 124-25.

         “The number of accounts Wells Fargo employees opened were also closely tracked. Several former Wells Fargo employees have recounted they were required to open 15 new accounts for products each day.” Id. ¶ 146. Daily sales for each branch were reported to the district manager four times a day. Id. And “[e]mployees who were unable to meet their sales goals faced the prospect of termination.” Id.

         Plaintiffs allege “[t]hose quotas translated into unrelenting pressure on bankers to open numerous accounts per customer.” Id. ¶ 2. “And because Wells Fargo's success in cross-selling was central to its financial results and market participants' assessment of the Company, Defendants were also highly motivated to foster, and perpetuate, those unlawful practices.” Id.

         D. Letter to Stumpf and the Audit and Examination Committee in September 2007

         In September 2007, Stumpf and the Board's Audit and Examination Committee received letters from an employee discussing how the Gr-Eight Initiative created a high pressure sales culture that resulted in unethical and illegal activity, including fraud. Id. ¶¶ 22, 484. The letter warned that, “[l]eft unchecked, the inevitable outcome shall be one of professional and reputational damage, consumer fraud and shareholder lawsuits, coupled with regulator sanctions. Id.

         E. EthicsLine

         Wells Fargo began tracking employee complaints regarding unethical sales practices through EthicsLine ‒ a service through which employees can report ethics and compliance concerns to Wells Fargo via a third party ‒ in 2008. Id. ¶¶ 23, 159. Through this system, employees could report “gaming” ‒ defined as “the manipulation and/or misrepresentation of product solutions or product solutions reporting in order to receive or attempt to receive compensation, or to meet or attempt to meet goals” and “sales incentives.” Id. ¶¶ 23, 158. After an employee reported an ethics or compliance concern through EthicsLine, the information was provided to Wells Fargo's Office of Global Ethics. Id. ¶ 151.

         Stumpf later confirmed in his written responses to questions posed by the Senate Banking Committee that “from at least 2011 forward, the Board's Audit and Examination Committee received period reports on activities of Wells Fargo's Internal Investigations group (which investigates issues involving team members), as well as information on EthicsLine and suspicious activity reporting. Among other things, several of those reports discussed increases in sales integrity issues or in notifications to law enforcement in part relating to the uptick in sales integrity issues.” Id. ¶ 155.

         F. Litigation between 2008 and 2013

         Between 2008 and 2013, several lawsuits against the company involved allegations of unauthorized account-creation practices. Id. ¶¶ 24-26, 33, 35, 212˗219, 501.

         In 2008 a former Wells Fargo employee won a whistleblower lawsuit against the company relating to the creation of fake brokerage accounts in 2008. Id. ¶ 24. “In the case, a division of the U.S. Department of Labor (“DOL”) found there was ‘reasonable cause to believe' Wells Fargo violated whistleblower protection laws by transferring the employee after he flagged illegal activity.” Id.

         In 2009, six former employees brought wrongful termination suits in which they alleged that they were fired for reordering debit cards without customer authorization after they had been instructed to do so by their manager. Id. ¶ 25, 213.

         In 2010, two former Wells Fargo employees filed a discrimination lawsuit in which they pointed to unethical sales activities and unauthorized account openings at the Company. Id. ¶¶ 26, 214.

         In 2012, seven former Wells Fargo employees filed a complaint asserting similar allegations. Id. ¶¶ 33, 217.

         In 2013, another former employee filed a lawsuit “alleging she was retaliated against and wrongfully terminated after her supervisor forced her to open accounts in the names of family members.” Id. ¶¶ 35, 218.

         G. Communications to Stumpf and Human Resources Executives in 2011

         In 2011, two branch managers ‒ one in New Jersey and one in Arizona ‒ emailed Stumpf warning him that employees were creating fake accounts to meet the company's sales quotas. Id. ¶ 28. One of those branch managers, Rasheeda Kamar, stated in her email that she was fired after failing to meet sales quotas because she did not tolerate the creation of fake accounts. Id. ¶ 200. The other branch manager, Ricky Hansen, reported the fraudulent accounts to Human Resources and EthicsLine. Id. ¶ 201-02. He was fired a month later for improperly looking up the fraudulent account information, which he did at EthicsLine's request. Id.

         H. Los Angeles Times Article in December 2013

         On December 21, 2013, the Los Angeles Times published an article reporting that, “[t]o meet quotas, [Wells Fargo] employees have opened unneeded accounts for customers, ordered credit cards without customers' permission and forged client signatures on paperwork.” Id. ¶ 37. The article further noted “[t]he relentless pressure to sell [that] has battered employee morale and led to ethical breaches.” Id. The article's conclusions were based on “a review of internal bank documents and court records, and from interviews with 28 former and seven current Wells Fargo employees who worked at bank branches in nine states, including California.” Id.

         Stumpf later admitted during his testimony before the Senate Banking Committee in September 2016 that he discussed the December 2013 Los Angeles Times article with the Board. Id. ¶ 40.

         I. Communication to Stumpf and the Board in April 2015

         On April 3, 2015, a former Wells Fargo banker mailed and emailed a letter to Stumpf and the Board advising them of ‘unethical practices in sales due to the continuous management threat of negative consequences if they did not produce ‘solutions' in double digits on daily basis, the threat has come to ‘do whatever it takes to get this [sic] numbers.'” Id. ¶¶ 44, 205. “During the next several months, the former employee repeatedly emailed Wells Fargo representatives, copying the Board, asking for updates.” Id. ¶ 44, 207.

         J. Litigation in May 2015

         The December 2013 Los Angeles Times article prompted a year-long investigation into the illicit account-creation practices by L.A. City Attorney Michael Feuer, which led to the filing on May 4, 2015 of a civil enforcement action on behalf of California consumers. Id. ¶ 42. In that complaint, the L.A. City Attorney alleged “that . . . Wells Fargo employees opened banking and financial accounts, products, and services for California customers without their knowledge or consent . . .” Id. ¶¶ 499, 172˗78, 42.

         On May 14, 2015, a consumer class action challenging the illicit account-creation scheme was filed against Wells Fargo in this district. Id. ¶¶ 45, 179-82, 500.

         K. OCC Supervisory Letters between 2014 and 2016

         The Office of the Comptroller of the Currency (“OCC”) began supervising Wells Fargo's governance and risk management practices in January 2012. Id. ¶ 31.

         In 2014, “[t]he OCC specifically identified the need to assess cross-selling and sales practices as part of its upcoming examination of the Bank's governance processes.” Id. ¶ 222.

         In 2015, the OCC issued several Supervisory Letters “regarding required corrective action in the Bank's enterprise-wide risk management and oversight of its sales practices, ” among other issues. Id. ¶ 485, 220-238, 46. For example, the OCC issued a Supervisory Letter in June 2015 highlighting the following “MRAs, ” or “Matters Requiring Attention”: “the lack of an appropriate control or oversight structure given corporate emphasis on product sales and cross-selling, ” “the lack of an enterprise-wide sales practices oversight program, ” “the lack of a formalized governance process to oversee sales practices and effectively oversee and test branch sales practices, ” and “the failure of the Bank's audit services to identify the above issues or to aggregate sales practice issues into an enterprise view.” Id. ¶ 503.[4]

         L. Consent Orders

         On September 8, 2016, the L.A. City Attorney, U.S. Consumer Financial Protection Bureau (CFPB) and the OCC issued separate consent orders and press releases disclosing widespread deficiencies and unsafe or unsound practices in Wells Fargo's risk management and oversight of its sales practices. Id. ¶ 9.

         The CFPB's consent order stated “that from January 1, 2011 to September 8, 2016 thousands of Wells Fargo employees engaged in improper sales practices ‘to satisfy sales goals and earn financial rewards under [the Company's] incentive-compensation program, ' leading the Company to terminate approximately 5, 300 employees for engaging in those practices.” Id. ¶ 10 (quoting Wells Fargo Bank, N.A., 2016-CFPB-0015 (Consumer Financial Protection Bureau Sept. 8, 2016)). “In all, the CFPB found that the Bank ‘opened hundreds of thousands of unauthorized deposit accounts and applied for tens of thousands of credit cards for consumers' without their knowledge or consent.” Id.

         M. ...


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