In one of the largest shareholder derivative lawsuit settlements ever, the parties to the consolidated Wells Fargo derivative suit arising out of the bank’s phony customer account scandal have agreed to settle the case for a variety of cash and non-cash benefits with a stated value to the company of $320 million, inclusive of a cash payment of $240 million. The $240 million cash portion of the settlement is to be paid by the bank’s D&O insurers, in what is, according to the plaintiffs’ counsel, “the largest insurer-funded cash component of any shareholder derivative settlement in history.” This settlement represents the latest in a series of derivative suit settlements with a significant cash component, a case resolution pattern in high-profile derivative suits that arguably represents the new normal in the world of D&O liability exposures.
The parties’ Stipulation of Settlement, filed with the court on February 28, 2019, can be found here. The plaintiffs’ February 28, 2019 Motion for Preliminary Approval of the Settlement can be found here. The Co-Lead Plaintiffs’ counsels’ February 28, 2019 press release about the settlement can be found here. The settlement is subject to court approval. The motion for preliminary approval is scheduled to be heard April 4, 2019.
The bank’s sales practices scandal arose out of a high-pressure sales strategy that led to as many as 2.1 million deposit and credit card accounts being created using fictitious or unauthorized customer information. In September 2016, fines and penalties totaling $185 million were imposed on the bank, including a $100 million fine by the Consumer Financing Protection Bureau, $35 million penalty to the Office of the Comptroller of the Currency, and another $50 million to the City and County of Los Angeles. In addition, in late March 2017, the bank agreed to a $110 million settlement of the consolidated class action that had been filed on behalf of bank customers who were affected by the improper sales practices.
As discussed in a prior post, in April 2017, following an independent board investigation, the bank imposed compensation clawbacks totaling over $180 million on certain former bank executives for their involvement in the fraudulent account scandal.
These various developments led to a host of lawsuits, including not only the derivative lawsuits but also a separate but related securities class action lawsuit that was settled in 2018 for $480 million (as discussed here).
The Derivative Lawsuits
Beginning in September 2016, a number of Wells Fargo shareholders filed a series of shareholder derivative lawsuits in the Northern District of California. These various derivative suits were later consolidated and the court appointed co-lead plaintiffs and co-lead counsel, after which the plaintiffs’ filed a consolidated amended complaint (here). In addition, a number of other Wells Fargo shareholders filed separate state court derivative actions relating to the bank’s alleged improper sales practices. These state court actions have either been stayed or dismissed.
The consolidated amended complaint alleged that the bank’s board and senior executives “perpetuated” a business-model based on aggressively cross-selling additional products to existing customers. Employees allegedly could face termination if they failed to meet allegedly “unreasonably high sales quotas.” These practices “effectively forced” its employees to open over two million unauthorized accounts. The company senior officials allegedly “knew or consciously disregarded that Wells Fargo employees were illicitly creating millions of deposit and credit card accounts for their customers, without these customers’ knowledge or consent.” The amended complaint contends that the defendants knew about and permitted these activities notwithstanding complaints to the company’s ethics line, several wrongful termination lawsuits, a whistleblower lawsuits, and a Los Angeles Times article that reported the fraudulent account creation activity.
The amended complaint asserted claims for breach of fiduciary duty; unjust enrichment; violations of the federal securities laws and the California Corporations Code; corporate waste; and contribution and indemnity. Plaintiffs sought declaratory relief, damages, injunctive relief, restitution, and attorneys’ fees.
The defendants filed a motion to dismiss the amended complaint. In an October 4, 2017 order (here), Northern District of California Judge Jon S. Tigar substantially denied the defendants’ motion to dismiss. The parties subsequently entered into mediation during 2017 and 2018. The mediation resulted in a mediators’ settlement proposal, which, in December 2018, the parties accepted. On February 28, 2019, the plaintiffs’ filed a motion for preliminary approval of the settlement with the court.
The Derivative Lawsuit Settlement
The settlement agreement consists of several parts: (1) a monetary payment of $240 million to be paid by the Insurers to Wells Fargo; (2) acknowledgement by Wells Fargo that the derivative suit was a significant factor in the company’s adoption during the suit’s pendency of a number of corporate governance reforms; (3) acknowledgement by Wells Fargo that the derivative suits were a significant factor in causing the remedial steps undertaken by Wells Fargo during the pendency of the actions, including compensation reductions and forfeitures involving certain bank executives. The parties agreed and offered to the court that the governance reforms and clawbacks have a combined value to Wells Fargo of $80 million, for a stated total settlement value of $320 million. The defendants have denied and continue to deny that all allegations of wrongdoing or liability.
The settlement includes an agreement and understanding that as part of the settlement hearing before the court, the co-lead plaintiffs’ counsel will apply to the court for an award of fees and expenses not to exceed $68 million, to be paid by Wells Fargo.
By any measure, this settlement is one of the largest shareholder derivative settlements ever. Just exactly where it fits on the derivative settlement league tables depends on how you look at it. The settlement’s stated value of $320 million would seem on its face to make it the largest derivative settlement ever, far exceeding the 2017 Activision Blizzard derivative settlement of $275 million. (For those readers who are interested, I have been trying to maintain a list of the largest derivative settlement, here.)
However, notwithstanding the settlement’s stated value of $320 million, the cash value of the Wells Fargo settlement is $240 million. In fact, in its most recent 10-K (here), in which the bank disclosed the settlement, Wells Fargo said only that the parties to the derivative suit have reached “an agreement in principle to resolve the shareholder derivative lawsuits pursuant to which insurance carriers will pay the Company approximately $240 million for alleged damage to the Company, and the Company will pay plaintiffs’ attorneys’ fees.” The company itself made no mention of the additional $80 million in value that brings the stated value of the settlement to $320 million. So, whether or not the Wells Fargo settlement is or is not bigger than the Activision Blizzard settlement is a matter of interpretation and perspective with respect to the settlement’s stated $320 million value.
A further complication to the trying to rank this latest settlement on the list of largest derivative settlements is the 2007 United Healthcare options backdating-related derivative suit settlement. As discussed here, the lawsuit settled for a total stated value of approximately $900 million. However, while the press reports at the time described the settlement as the largest derivative settlement ever, the value contributed to the settlement consisted of the surrender by the individual defendants of certain rights, interests, and stock option awards, not cash value in that amount.
The co-lead plaintiffs do not attempt to try to rank the Wells Fargo settlement on the overall league table. Instead, the plaintiffs assert in the motion for preliminary approval that the settlement includes “the largest insurer-funded cash component of any shareholder derivative settlement in history.” The motion papers include a table (on numbered pages 16-17 of the document) showing among other things no prior derivative settlement has previously involved an insurer-funded payment in excess of $139 million. (The $275 million Activision Blizzard settlement, according to the plaintiffs’ table of settlements, involved insurer contributions of approximately $57.5 million, the balance of the settlement funded by two corporate defendants.)
In any event, the Wells Fargo derivative suit settlement represents a very significant development. Among other things, it is the latest example of the way in which shareholder derivative settlements now increasingly involve a significant cash component. In the past, it was relatively uncommon for derivative lawsuit settlement to involve a significant cash element. Typically, derivative settlements in the past involved an agreement to adopt corporate therapeutics and the payment of plaintiffs’ attorneys’ fees. In the last ten years, it has become increasingly common for high-profile derivative suit settlements to involve a significant cash component. It is clear that derivative lawsuits now present a severity risk for companies and their insurers, which was not the case in the past.
As the massive amount of insurance money that is going toward this settlement demonstrates, the advent of a significant cash contribution component in derivative settlements represents a very serious problem for D&O insurers. The massive increase in the cash component of derivative settlements is one more change in the D&O litigation arena that significantly increases the D&O insurers’ potential exposure. This arguably is a particular concern for excess D&O insurers, as these massive losses now push into the high attaching excess layers in a way they would not have in the past. Moreover, the advent of this change in derivative suit settlements over the last few years has coincided with the period in which D&O insurance premiums have significantly decreased (particularly the premiums for high attaching excess insurance). Recently, the carriers have tried to start pushing back on premiums, arguing that they are not being adequately compensated for the risks they are undertaking.
The one thing that seems certain is that given the plaintiffs’ lawyers’ hoped-for payday of $68 million, the plaintiffs’ bar will certain have incentives to pursue more claims of this type. To be sure, the Wells Fargo case was unusual and involved allegations of significant wrongdoing. There are however, a host of current corporate scandals out there (e.g., Tesla, PGE&E, Kraft Heinz) that arguably also raise serious allegations.
A couple of final thoughts about this settlement. Given that it involves the settlement of a derivative suit, the settlement presumably is non-indemnifiable, meaning that Side A coverage of the policies of the settling insurers is the operative coverage part. This in turn means that the Excess Side A coverage of any Side A DIC policies in Wells Fargo’s insurance tower likely were triggered as well. Without knowing more about Wells Fargo’s insurance tower, it is hard to know whether or to what extent the group of contributing insurers included Side A DIC carriers. Certainly, higher attaching excess layers in Wells Fargo’s program are being called in.
The question whether or not the high attaching excess insurers and any contributing Side A DIC insurers were adequately compensated for taking on risks of this type is an interesting question – and arguably an interesting question as the D&O insurers at a time in the marketplace when the D&O insurers are trying to recalibrate their pricing to make it more commensurate with the risk.
My final observation with this settlement is just to register mild surprise that at this point in the proceedings there was still $240 million left in Wells Fargo tower to fund this settlement. The bank and its various directors and officers undoubtedly have incurred tens of millions of dollars in defense expenses in the various related matters. The separate securities class action lawsuit relating to these same allegations settled last year for $480 million. Given all of these likely prior expenses, it seems noteworthy that the enough insurance remains for the carriers to contribute $240 million at this point to the settlement.
It may be that, in light of the priority of payments provisions in the primary policy (and applicable to the excess carriers through their follow-form coverage) that priority of the policy proceeds for the liabilities of the individual insureds meant that defense and settlement of this derivative action took priority, while the company itself funded the defense and settlement of other matters. The reality likely was more complicated, but I suspect that the priority of payments provision did come into play here.
Special thanks to a loyal reader for alerting me to the settlement and for providing me with several of the important settlement documents.