Wells Fargo Securities Litigation, In re

• Decision Date: 29 December 1993
• Docket Number: No. 92-15344,92-15344
• Citation: 12 F.3d 922
• Parties: Fed. Sec. L. Rep. P 98,007 In re WELLS FARGO SECURITIES LITIGATION. Howard GREENWALD; Milton Friedman; Sheldon Shore; John Paul Decker; Fairmont Financial Corporation; Arthur-Magna Inc; Harold Bloch; Robert C. Schilling, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. WELLS FARGO & CO., a Delaware Corporation; Carl E. Reichardt; Paul Hazen; Robert L. Joss; Clyde Ostler; David M. Petrone; William F. Zuendt; Stephen A. Enna; Rodney L. Jacobs; Patrick W. Leahy; Guy Rounsaville, Jr., Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 922

12 F.3d 922

Fed. Sec. L. Rep. P 98,007

In re WELLS FARGO SECURITIES LITIGATION Howard GREENWALD; Milton Friedman; Sheldon Shore; John Paul Decker; Fairmont Financial Corporation; Arthur-Magna Inc; Harold Bloch; Robert C. Schilling, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. WELLS FARGO & CO., a Delaware Corporation; Carl E Reichardt; Paul Hazen; Robert L. Joss; Clyde Ostler David M. Petrone; William F. Zuendt; Stephen A. Enna Rodney L. Jacobs; Patrick W. Leahy; Guy Rounsaville, Jr., Defendants-Appellees.

No. 92-15344.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 10, 1993.

Decided Dec. 29, 1993.

William S. Lerach, Milberg, Weiss, Bershad, Hynes & Lerach, San Diego, CA, and Elizabeth Joan Cabraser, Lieff, Cabraser & Heimann, San Francisco, CA, for plaintiffs-appellants.

Melvin R. Goldman, Morrison & Foerster, San Francisco, CA, for defendants-appellees.

Appeal from the United States District Court for the Northern District of California.

Before: REINHARDT, TROTT, and RYMER, Circuit Judges.

RYMER, Circuit Judge:

Purchasers of Wells Fargo & Co. common stock ("shareholders") appeal from the district court's order dismissing their securities fraud class action with prejudice pursuant to Federal Rule of Civil Procedure 12(b)(6). ¹ In their Amended Complaint, the shareholders allege that Wells Fargo & Co. and certain of its senior officers and directors (collectively "Wells Fargo") violated Sec. 10(b) of the Securities Exchange Act of 1934 (" '34 Act"), 15 U.S.C. Sec. 78j(b); the SEC's Rule 10b-5, 17 C.F.R. Sec. 240.10b-5; Sec. 20 of the '34 Act, 15 U.S.C. Sec. 78t; and California Civil Code Secs. 1709-10 by fraudulently withholding material information and by issuing a series of false and misleading statements relating to the level of loan loss reserves maintained by Wells Fargo & Co.'s banking subsidiary, Wells Fargo Bank. ² The shareholders claim that these omissions and misrepresentations served to inflate artificially the trading price of Wells Fargo & Co. stock, thus causing financial injury to those who purchased the overpriced shares. We have jurisdiction under 28 U.S.C. Sec. 1291, and we reverse.

I

On June 25, 1991, Wells Fargo & Co. issued a statement that Wells Fargo Bank would recognize $180 million in actual loan losses for the second quarter ending June 30, 1991, and that the Bank expected to add approximately $350 million to its loan loss reserves for that same period. Wells Fargo's disclosure precipitated a sharp drop in the trading price of its stock--from a pre-announcement high of $97 per share to $74 per share. Shareholders who purchased Wells Fargo stock between March 5, 1991, when the company issued its 1990 Annual Report to Shareholders and filed its Form 10-K with the SEC, and June 25, 1991, the date that Wells Fargo disclosed that it would increase loan loss reserves for the second quarter, filed their amended class action complaint on August 26, 1991.

The theory of securities fraud advanced by the shareholders' Amended Complaint is that Wells Fargo maintained the inflated trading price of its common stock by failing to disclose the status of certain loans that it knew were in jeopardy. More specifically, the shareholders allege that senior directors and officers of Wells Fargo, motivated by the desire to "continue and prolong the image of Wells Fargo as a well-managed enterprise with sound lending procedures" and thus, maximize their individual compensation, the value of their personal Wells Fargo & Co. stock holdings, and their job security, became aware in March 1991 that the Bank's commercial, real estate, and highly leveraged loan portfolios had been mismanaged, were "not fundamentally sound and [were] prone to non-repayment in foreseeable and predictable economic downturns." Nonetheless, according to the shareholders, Wells Fargo was able to maintain the high value of its stock "through the issuance of materially false and misleading reports filed with the SEC, annual and quarterly reports to shareholders, releases to the public and financial statements," all intended to conceal "how poorly Wells Fargo had been managed by the Individual Defendants and how badly its financial and operating condition had deteriorated." Primary among Wells Fargo's alleged methods of deception was a deliberate understatement of loan loss reserves, ³ effected through Wells Fargo's failure timely to recognize known problem loans and failure to adjust loan loss reserves "at an appropriate level consistent with the [known] risk of loss actually faced."

In its Order Granting Defendants' Motion to Dismiss the shareholders' complaint for failure to state a claim, the district court held that "[n]othing in plaintiffs' voluminous complaint states facts which support a coherent theory of securities fraud." The court concluded that the shareholders' Amended Complaint alleged non-actionable "fraud by hindsight," and characterized the shareholders' suit, purportedly based on a three-month conspiracy among the defendants to conceal or misrepresent the Bank's financial health by understating loan loss provisions, as one more accurately describing mismanagement by Wells Fargo, or perhaps a violation of the applicable banking regulations. As the district court explained, "[t]he fact that defendants increased loan loss reserves in the second quarter, and at all times relevant accurately reported the amount of actual reserves set aside by the bank, does not by itself allege securities fraud, notwithstanding conclusory statements of fraud in the complaint." Stating that the shareholders' Amended Complaint, "a collaborative effort by a dozen law firms with significant experience in [the] field of securities litigation," "cannot be further improved," the district court granted Wells Fargo's motion to dismiss the federal securities law causes of action with prejudice. Finally, pursuant to 28 U.S.C. Sec. 1367(c)(3), the court declined to exercise its supplemental jurisdiction to hear the shareholders' two remaining state law claims.

II

A dismissal for failure to state a claim pursuant to Federal Rule of Civil Procedure 12(b)(6) is a ruling on a question of law and as such is reviewed de novo. Oscar v. University Students Co-op. Ass'n, 965 F.2d 783, 785 (9th Cir.) (en banc), cert. denied, --- U.S. ----, 113 S.Ct. 655, 121 L.Ed.2d 581 (1992). All allegations of material fact are taken as true and construed in the light most favorable to the plaintiff. Love v. United States, 915 F.2d 1242, 1245 (9th Cir.1989).

III

A

The shareholders contend that the allegation that Wells Fargo intentionally or recklessly understated its loan loss reserves in an effort to inflate corporate earnings (and therefore earnings per share), and then disseminated financial statements reflecting this misallocation to the public and to the SEC, states a claim under Sec. 10(b) and Rule 10b-5. Noting that a bank's loan loss reserve is set based on the risk of loss posed by the aggregate of a bank's loan transactions, the shareholders argue that the deliberate failure to recognize problem loans, thus understating the reserve, constitutes an actionable omission or misrepresentation of existing fact which cannot be dismissed as a mere matter of internal mismanagement, unsound business practice, or poor accounting judgment.

The shareholders are correct. To state a claim under Sec. 10(b) and Rule 10b-5, the shareholders must allege that Wells Fargo knowingly or recklessly published an "untrue statement of fact" or omitted to state a material fact "necessary to make the statements made, in light of all the circumstances in which they were made, not misleading." In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir.1989), cert. denied, 496 U.S. 943, 110 S.Ct. 3229, 110 L.Ed.2d 676 (1990). Wells Fargo's financial statements contain no "untrue statements of fact"--the shareholders do not dispute that Wells Fargo accurately disclosed the amount allocated by the Bank to its loan loss reserves. Thus, the shareholders must identify some omission of material fact necessary to make Wells Fargo's literally accurate reporting of the size of its reserve not misleading. In substance, the shareholders allege that Wells Fargo's statement of its loan loss reserves failed to disclose--i.e., failed to reflect--certain loans that Wells Fargo knew were "in jeopardy." The shareholders list a representative selection of those bad loans which, in their view, Wells Fargo should have recognized by adjusting its reserves accordingly. Alleged problem loans, of which Wells Fargo was "on notice" prior to the start of the Class Period and failed properly to disclose, include loans extended to Revco D.S., Insilco Corp., Charter Medical Corp., R.H. Macy & Co., Campeau Corp., Jim Walters Corp., Gaylord Container Corp., West Point Pepperell, Inc., and NWA, Inc. The shareholders allege that Wells Fargo's non-performing assets and its reserves for possible loan losses were understated by at least $400 million and $350 million respectively, due to defaults on and the doubtful collectability of a number of its loans.

Accurate information regarding a bank's specific, substantial loans, with respect to which the alleged understating of value totals nearly $400 million in this case, cannot be deemed non-material as a matter of law. In Shapiro v. UJB Fin. Corp., 964 F.2d 272, 276-77 & n. 6 (3d Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 365, 121 L.Ed.2d 278 (1992), plaintiffs alleged that UJB Corp. fraudulently inflated its "earnings, assets, and net worth" by understating "its non-performing loans" and by failing "to provide adequate loan loss reserves for problem loans promptly and properly." The plaintiffs further alleged that UJB issued a series of statements which "misrepresented the true status of the company's loan loss reserves, financial health, lending practices, and internal controls."...