|Footnotes for this article are available at the end of this page.
On Friday, November 13, 2020, the U.S. Securities and Exchange Commission (“SEC” or “Agency”) followed up its February 2020 action against Wells Fargo & Co. (“Wells Fargo”) with actions against two senior officers—former Chairman and CEO of Wells Fargo, John Stumpf, who agreed to an SEC administrative cease and desist order, and $2.5 million in penalties, and former head of Wells Fargo’s Community Bank (“Community Bank”), Carrie Tolstedt, who did not settle with the SEC. The SEC filed a civil complaint in the U.S. District Court for the Northern District of California against her, claiming that Tolstedt had violated “the antifraud provisions of the federal securities laws” and seeking to have a “permanent injunction, civil penalties, disgorgement with prejudgment interest, and an officer-and-director bar” imposed against her.1
On February 21, 2020, the SEC filed a settled administrative proceeding against Wells Fargo and ordered a payment of $500 million from the bank to the bank’s shareholders as part of a “combined $3 billion settlement with the SEC and the U.S. Department of Justice.”2 (“Wells Fargo Action”). In the Wells Fargo Action, the SEC found that, from 2012 through 2016, Wells Fargo had “misled investors regarding the success of the core business strategy of the Community Bank operating segment, its largest business unit.”3
In its SEC filings, Wells Fargo published a “cross-sell metric,” a ratio of numbers of accounts and products per retail bank household. In presentations and conferences, it informed investors and analysts that its business-growth strategy centered on increasing this ratio. The ratio could be increased by creating new customer accounts and selling products, or by selling more products to existing customers. The Community Bank chose to use the second strategy to meet sales goals, and implemented a volume-based sales model under which managers pressured employees to sell additional products to existing customers, regardless of their need. Under this pressure, employees met inflated sales targets by making fraudulent statements, stealing identities, and falsifying bank records to open accounts of low or no value to customers that the employees knew customers did not need and would not use. As a consequence, Wells Fargo opened millions of unauthorized or fraudulent accounts.4
In the Wells Fargo Action, the SEC alleged that Wells Fargo’s senior leadership was aware of the fraudulent practices, but did not disclose that the Community Bank’s sales model had caused widespread unlawful and unethical sales practices to increase the cross-sell metric and show apparent business growth. The SEC alleged that certain senior executives who reviewed or approved the disclosures for investors knew, or were reckless in not knowing, that these disclosures were misleading or incomplete. In responding to SEC Staff comment letters seeking clarification of how the cross-sell metric was calculated, Wells Fargo provided misleading responses.5 As a result of these actions, Wells Fargo admitted to violations of Section 10(b) of the Exchange Act and Rule 10b-5 prohibiting fraudulent conduct in connection with the purchase or sale of securities,6 and entered into a Deferred Prosecution Agreement with the Department of Justice.
The SEC’s Assertions in its Settled Proceeding and Order Against Stumpf
In 2015 and 2016, according to the SEC, Stumpf, as CEO of Wells Fargo, signed and certified materially misleading annual and quarterly reports that it filed with the Agency. The SEC found that statements contained in these reports about the cross-sell metrics were material to investors and were false and that Stumpf knew or was reckless in not knowing they were false.
According to the SEC, Stumpf received information that put him on notice that Well Fargo’s statements about the Community Bank’s cross-selling strategy and its cross-sell metric in reports from the second quarter of 2015 to the second quarter of 2016, were materially false. The SEC found that Stumpf’s reliance on Tolstedt, and other senior officers who had assured him that the statements were materially accurate, was unreasonable.7
In 2013, the Los Angeles Times reported that Wells Fargo had fired approximately 30 employees in the Los Angeles, California area for sales-related misconduct. In a subsequent article in December 2013, the Times followed up with reports of bankers ordering credit cards without customers’ permission, forging client signatures, and beseeching their own family members to open “ghost accounts.”8
In April 2015, the Wells Fargo Board’s Risk Committee received Tolstedt’s presentation about the sales misconduct issues reported in late 2013. The chair of the Risk Committee (“Chair”) was dissatisfied with Tolstedt’s presentation and her downplaying of the problem and contacted Stumpf and Wells Fargo’s Chief Risk Officer (“CRO”) to request more information about these issues.
In early May 2015, the City of Los Angeles sued Wells Fargo for having opened accounts without customer consent, after which the Chair asked Tolstedt to make a second presentation about the Community Bank’s sales practices. Before that second Risk Committee meeting, Stumpf met with Tolstedt to preview her presentation. At her presentation, Tolstedt understated the number of people terminated for sales misconduct.
Shortly after the second, May 2015 Risk Committee meeting, concerned that Tolstedts’ presentation had minimized the problem, the Chair asked that the CRO engage an external consultant to investigate the scope and causes of the misconduct.9 In October 2015, the external consultant reported a misalignment between the bank’s messages concerning customer relationships and the sales goals and performance expectations applied to its bankers. Wells Fargo’s internal systems, moreover, often failed to capture customer complaints and ethics issues. The consulting firm recommended that management review sales goal-setting and reward employees on customers’ use of their accounts rather than on the number of accounts or products sold. At that same meeting, Tolstedt again provided what the Risk Committee considered to be an unacceptable presentation. After the meeting, the Chair and another board member met with Stumpf and recommended that he remove Tolstedt as head of the Community Bank.10
Stumpf, however, retained Tolstedt as head of the Community Bank but restructured her reporting so she no longer reported directly to him but to Wells Fargo’s Chief Operating Officer (“COO”), who reported to Stumpf, instead. In November 2015, Tolstedt and her team proposed redefining key terms in the cross-sell metric to reflect only “active” accounts and restricting “households” in the denominator to those with a primary checking account, which would produce a significantly smaller denominator so that the cross-sell metric ratio would show faster and greater increases.11 The suggestion was eventually accepted in July of the following year.
Although he knew that the cross-sell metric included accounts that were not in actual use and that exclusion of inactive accounts would materially change the results shown by the metric, Stumpf signed and certified Wells Fargo’s quarterly and annual reports describing the metric as “the relationship of all retail products used by customers in retail banking households” as materially accurate.12
Later, in July 2016, Wells Fargo further changed the definition of “households” in the denominator of the cross-sell metric to reflect only those with a retail checking account, which had the effect of increasing the metric across periods.13 Wells Fargo did not, however, make the other change, to reflect only actively used accounts.
The SEC concluded that Stumpf violated Section 17(a)(2) of the Securities Act, which makes unlawful the receipt of money or property through misstatements or omissions about material facts, and Section 17(a)(3) of the Securities Act, which makes unlawful any transaction or course of business that operates or would operate as a fraud or deceit upon a purchaser of securities. The SEC noted that these provisions can be violated even without specific intent or recklessness, and may be based on a finding of negligence.14 The Order requires Stumpf to cease and desist from any further violations of these provisions and orders him to pay a civil monetary payment of $2.5 million to the SEC to be added to the Fair Fund proceeds of $500 million to be paid to Wells Fargo shareholders as a result of the February 2020 action against the company.
The SEC’s District Court Action Against Tolstedt
Tolstedt did not settle with the SEC. On the day that the settlement with Stumpf was announced, the SEC sued Tolstedt in federal court alleging violations of Exchange Act Section 10(b) and Rule 10b-5 thereunder (the securities fraud provisions), Securities Act Sections 17(a)(1), (2), and (3) (including both provisions that require a showing of recklessness and those requiring simple negligence), aiding and abetting violations of Exchange Act Section 13(a) (Well Fargo’s requirements to file accurate periodic reports with the SEC), and aiding and abetting violations of Exchange Act Section 13(b)(2)(A) (Wells Fargo’s requirement to maintain accurate books and records).
The Question of Materiality
Tolstedt and her counsel may believe that the motion to dismiss can provide better leverage than a pre-filing settlement: making the SEC confront the potential weaknesses in its case in the litigation context might result in a more favorable outcome or even victory for Tolstedt.
Whether the SEC is successful against Tolstedt depends on whether Wells Fargo’s reports of its cross-sell metrics were materially misleading. This depends, in turn, on whether Wells Fargo’s failure to disclose that for many of the accounts, customers neither wanted nor used them actively, and that, in many instances, Wells Fargo created these accounts fraudulently or without authorization. The SEC’s case is built on the view that a “reasonable investor” would likely view Wells Fargo’s growth metric, as calculated, and the conduct that it engendered, as significantly altering the “total mix” of information available.15 In this regard, Wells Fargo’s price dropped precipitously after the February 21, 2020 announcement of the DOJ and SEC actions against the company,16 a possible indication that the conduct revealed in the settlement was material to investors. On the other hand, that announcement came wrapped in an SEC enforcement settlement and a DOJ Deferred Prosecution Agreement, so the market’s reaction may have had less to do with Wells Fargo’s underlying disclosures than the government’s reaction to them.
The SEC, in our opinion, will likely prevail in responding to Tolstedt’s inevitable motion to dismiss, since the standard at that point will simply be whether the complaint’s allegations, which must be accepted as true for the purpose of the motion, adequately allege securities fraud violations. We will follow the litigation with interest.
 SEC, Press Release, SEC Charges Former Wells Fargo Executives for Misleading Investors About Key Performance Metric (Nov. 13, 2020) https://www.sec.gov/news/press-release/2020-281.
 SEC, Press Release, Wells Fargo to Pay $500 Million for Misleading Investors About the Success of Its Largest Business Unit (Feb. 21, 2020) https://www.sec.gov/news/press-release/2020-38.
 Wells Fargo & Co., Exchange Act Rel. No. 88257, Admin. Proceeding No. 3-19704 at 2 (Feb. 21, 2020) https://www.sec.gov/litigation/admin/2020/34-88257.pdf.
 Id. at 3.
 Id. at 12.
 John G. Stumpf, Exchange Act Rel. No. 10887, Admin. Proceeding No. 3-20148 at 2 (Nov. 13, 2020) https://www.sec.gov/litigation/admin/2020/33-10887.pdf.
 Id. at 3.
 Id. at 5-6.
 Id. at 7.
 Id. at 7-8.
 Id. at 8 (emphasis added).
 Id. at 9-10.
 Id. at 10 (citing Aaron v. SEC, 446 U.S. 680, 685, 701-02 (1980)).
 See Basic Inc. v. Levinson, 485 U.S. 224 (1988).
 Dropping by more than 40% over the ensuing 3 weeks.