Wells Fargo & Co., citing “new facts,” asked a judge to revoke the class-action status he bestowed on a suit by institutional investors who claimed the bank marketed a risky securities-lending program as safe.
Wells Fargo today asked U.S. District Judge Donovan W. Frank in St. Paul, Minnesota, to revisit his decision allowing the plaintiffs to pursue their action together instead of individually, giving them greater leverage to obtain a settlement. The bank is also seeking dismissal of multiple investor claims.
Frank certified the case as a group lawsuit last year, finding that common questions predominated, including whether San Francisco-based Wells Fargo “knew or should have known that the investments it selected did not comport with investment mandates.”
The case was filed in 2010 by the City of Farmington Hills Employees Retirement System, a Michigan pension fund, on behalf of more than 100 other institutional investors. They claim breach of fiduciary duty and fraud.
“There are significant new facts that have come to light and significant new arguments that have come to light that could not have been known at the time of certification,” Dan Millea, a Wells Fargo attorney, told the judge today.
The lead plaintiff, Farmington Hills, differs from other investors and there’s no classwide method for calculating damages, Millea said. “Farmington Hills exited the program and sold out completely. Other members are either still in or paid to get out.”
These differences don’t mean that a class shouldn’t be certified, Peter Binkow, a lawyer for the plaintiffs, said at the hearing. Damages would be calculated by how much principal was lost, he told the judge. How investors got into or out of the program doesn’t matter, he said.
“There’s really no issue on damages.” he said.
The suit, set for trial Sept. 16, is one of at least five against Wells Fargo over its securities lending. A case brought by nonprofit organizations led by Blue Cross Blue Shield of Minnesota goes to trial next month in federal court in St. Paul. In another, the Minnesota Life Insurance Co. claims $40 million in damages.
Wells Fargo lost a $30 million jury verdict in 2010 in a claim brought by the Minnesota Workers’ Compensation Reinsurance Association and three charitable foundations. The verdict was upheld on appeal. The suits have been brought in Minnesota where the Wells Fargo securities lending program was located.
Investments made by Wells Fargo Securities Lending “were in accordance with investment guidelines and were prudent and suitable at the time of purchase,” Laura Fay, a spokeswoman for the bank, said in an e-mailed statement. “We strongly deny the allegations that were made in these lawsuits.”
Securities lending is a practice whereby investors lend stock or other investments to banks or brokers. In return, the bank places cash collateral on behalf of the investor into short-term investments until the shares are returned. It has been traditionally viewed by pension funds and foundations as a low-risk investment.
The pension fund and other class members participated in an investment program in which Wells Fargo would hold its clients’ securities in custodial accounts and make temporary loans of these securities to brokers.
The brokers would borrow the securities to support their trading activities, such as short sales and option contracts, and would post collateral worth at least 102 percent of the value of the securities, the plaintiffs said in court papers.
The Michigan pension plan claims Wells Fargo promoted its securities-lending program “as a highly secure way for its institutional clients to maximize portfolio returns.” Instead, the pension fund said, “Wells Fargo invested a substantial portion of the collateral in extremely risky securities.”
Wells Fargo also invested in “highly illiquid securities,” including structured investment vehicles, or SIVs, asset-backed and mortgage-backed securities, the plaintiffs said in the complaint. The SIVs proved particularly risky during the mortgage crisis, they said.
“We do not believe that Wells Fargo in any meaningful manner tried to assess liquidity,” plaintiffs’ attorney Avi Wagner said at today’s hearing.
The investors claim Wells Fargo concealed investment performance to keep them from exiting the lending program. They allege breach of fiduciary duty, breach of contract and violation of Minnesota’s Consumer Fraud Act.
The class includes participants in the Wells Fargo securities lending program starting on Jan. 1, 2006, “who suffered losses to the program’s purchase and maintenance of high risk, long-term securities,” Frank said in his order.
Wells Fargo blamed any losses on the financial crisis.
“Market conditions severely deteriorated and had a major impact on the global financial markets and worldwide economies” from 2007 to 2009, said Fay, the bank spokeswoman. “During that time, the market for even the highest-rated debt instruments, such as those invested in by WFSL, deteriorated substantially.”
The Michigan pension fund and the class “suffered no recoverable damages,” lawyers for the bank said in court papers in November. “Any losses sustained by plaintiff and the class were caused by persons, entities or other factors for which Wells Fargo was not and is not responsible.”
Alleged losses were “offset, in whole or in part, by profits in their accounts with Wells Fargo and profits arising from purchases of other fixed-income instruments that would be considered ‘unsuitable’ according to the allegations of plaintiff and the class,” the bank’s attorneys wrote.
Wells Fargo also asked the judge today to dismiss claims for breach of fiduciary duty and the consumer law violation.
The plaintiffs haven’t proven that “but for” Wells Fargo’s actions, investment losses wouldn’t have occurred, Lindsey Davis, an attorney for the bank, said at the hearing.
“The plaintiffs have not created a ‘but for’ world comprised of appropriate investments,” she said.
In approving a class action, the judge wrote that it is superior to multiple individual suits in promoting “the interests of judicial economy and efficiency.”
“Class members who may not otherwise have the means to litigate their claims will likely benefit greatly from a class action, and a class action will ensure that class members who are otherwise unaware that they possess a claim will have their rights represented,” he wrote.
The suit particularly targets Wells Fargo’s investments in structured investment vehicles. The plaintiffs sought “conservative, safe and liquid investments,” their lawyers wrote. “SIVs have a built-in illiquidity risk.”
“SIVs borrow money by issuing short-term securities, usually commercial paper, at lower interest rates,” according to the complaint. “The SIVs then lend money by buying long-term assets at higher interest rates,” making a profit off the spread, the lawyers said.
“To survive, SIVs need a constant infusion of new short-term refinancing, at favorable rates,” they said. This financing fell apart when the mortgage crisis caused a “liquidity crunch” in the short-term commercial paper market, leading to defaults by two of the SIVs in which Wells Fargo had heavily invested, Cheyne Finance SIV and the Stanfield Victoria SIV, according to the complaint. Both went into receivership, the plaintiffs’ lawyers said.
Frank will first oversee a trial to start June 17 in a case brought against Wells Fargo by Blue Cross & Blue Shield of Minnesota and 10 other nonprofits, including the pension plans of St. John’s University, Meijer Inc. and El Paso County.
The class action is City of Farmington Hills Employees Retirement System v. Wells Fargo Bank NA, 10-cv-04372, U.S. District Court, District of Minnesota (St. Paul).